[Senate Hearing 111-886]
[From the U.S. Government Publishing Office]
S. Hrg. 111-886
A COMPARISON OF INTERNATIONAL HOUSING FINANCE SYSTEMS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
SECURITY AND INTERNATIONAL TRADE AND FINANCE
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
ON
COMPARING THE INTERNATIONAL HOUSING FINANCE SYSTEMS
__________
SEPTEMBER 29, 2010
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York JIM BUNNING, Kentucky
EVAN BAYH, Indiana MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey MEL MARTINEZ, Florida
DANIEL K. AKAKA, Hawaii BOB CORKER, Tennessee
SHERROD BROWN, Ohio JIM DeMINT, South Carolina
JON TESTER, Montana DAVID VITTER, Louisiana
HERB KOHL, Wisconsin MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia KAY BAILEY HUTCHISON, Texas
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado
Edward Silverman, Staff Director
William D. Duhnke, Republican Staff Director and Counsel
Dawn Ratliff, Chief Clerk
William Fields, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Security and International Trade and Finance
EVAN BAYH, Indiana, Chairman
BOB CORKER, Tennessee, Ranking Republican Member
HERB KOHL, Wisconsin ROBERT F. BENNETT, Utah
MARK R. WARNER, Virginia
MICHAEL F. BENNET, Colorado
CHRISTOPHER J. DODD, Connecticut
Ellen Chube, Staff Director
Courtney Geduldig, Republican Staff Director
(ii)
?
C O N T E N T S
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WEDNESDAY, SEPTEMBER 29, 2010
Page
Opening statement of Chairman Bayh............................... 1
Opening statements, comments, or prepared statement of:
Senator Corker............................................... 3
WITNESSES
Michael J. Lea, Director, The Corky McMillin Center for Real
Estate, San Diego State University............................. 4
Prepared statement........................................... 26
Susan M. Wachter, Richard B. Worley Professor of Financial
Management, Professor of Real Estate, Finance, and City and
Regional Planning, The Wharton School, University of
Pennsylvania................................................... 7
Prepared statement........................................... 108
Alex J. Pollock, Resident Fellow, American Enterprise Institute.. 9
Prepared statement........................................... 110
(iii)
A COMPARISON OF INTERNATIONAL HOUSING FINANCE SYSTEMS
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WEDNESDAY, SEPTEMBER 29, 2010
U.S. Senate,
Subcommittee on Security and International Trade and
Finance,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 2:36 p.m., in
room SD-538, Dirksen Senate Office Building, Hon. Evan Bayh,
Chairman of the Subcommittee, presiding.
OPENING STATEMENT OF CHAIRMAN EVAN BAYH
Chairman Bayh. If the Subcommittee would please come to
order. Good afternoon. I am pleased to call to order this
Subcommittee hearing entitled, ``A Comparison of International
Housing Finance Systems.'' I want to thank and welcome my
colleague in attendance, Senator Corker, and I am happy to say
that we have had an excellent working relationship, to show
that Democrats and Republicans can cooperate together when the
spirit so moves us. So, Robert, it is great to be with you once
again. As a matter of fact, if I have to absent myself later, I
have such trust and confidence in my colleague, I will hand him
the gavel.
[Laughter.]
Chairman Bayh. Which does not happen much here on Capitol
Hill, but it will be in good hands when it is in his. He was,
in fact, the impetus behind holding this hearing and having
this important discussion today.
To our three distinguished and learned witnesses that
appear before us today, welcome and thank you for your
testimony.
All three of the academics on our panel have extensive
research and practical experience in the area of housing
finance, with a particular expertise in the systems of
developed nations abroad. I understand that two of our
witnesses have traveled to be with us here today, and so I want
to thank you for your time and consideration with regard to the
Subcommittee's deliberations. Thank you for literally going the
extra mile.
I look forward to our dialog today, but, unfortunately, due
to some last-minute scheduling constraints, I may be unable to
stay for the entirety of the hearing. I am confident, however,
that given Senator Corker's keen interest in this issue and the
appeal of the subject matter, we will still have a lively and
informative discussion.
If the witnesses will indulge me, I may have a few written
follow-up questions for you to be submitted for the record on
certain topics that are not covered in the question-and-answer
portion of today's hearing. I promise they will not be too
voluminous.
Before we turn to the panel, I would like to give a few
very brief remarks to provide some context for this hearing and
what the Subcommittee would like to achieve today. And I invite
Senator Corker to do the same when I am done.
Today we convene as a Subcommittee to gain insight into the
legislative challenge facing Congress as it considers reforms
to our housing finance system. This is a critical economic
policy issue that affects virtually all of those involved in
the housing market: homeowners, potential borrowers, financial
institutions, investors, realtors, construction, and I could go
on and on.
Many with an interest in reform are already hard at work.
Last month, the Treasury Department held a conference on the
future of housing finance. Some of our witnesses today
participated in that conference, and it proved to be a
worthwhile and substantive meeting.
Just last week, Assistant Secretary Barr reiterated the
Treasury Department's intention to release a plan that will
call for fundamental change by January 2011. This debate has
the potential to become political and polarizing, but that
should not prevent us from addressing such a consequential
issue in a pragmatic fashion.
It is the responsibility of Congress to tackle how to build
a more stable housing finance system, with an understanding of
what went wrong with our current system and what we can do
together, given the economic realities, to fix it.
To assist in that endeavor, we hold today's hearing to
explore the housing finance models of other developed nations,
including, but not limited to, Canada, Denmark, the United
Kingdom, Australia, and Germany. We will hear from the
witnesses on how the housing finance systems of these countries
differ from the United States', the strengths and weaknesses of
their product approach, and whether any lessons may be learned
from their experiences prior to enduring the global economic
crisis. More importantly, we hope to learn whether any aspects
of their systems and policies or regulatory frameworks may be
adapted to our system here in the United States.
As a lead-in to that discussion, I would note that some of
the policy approaches of other nations are seemingly difficult
to reconcile with the economic data. For instance, most
developed countries experienced robust growth in their housing
and mortgage markets during the first half of the decade. Some
countries also experienced record levels of house price
inflation, relaxed underwriting standards, and increased
competition. Still, no other major developed nation has
experienced the type of house price decline, the staggering
default and foreclosure rates, and drastic change to their
mortgage finance system that the U.S. went through. Why is
that? What have they done differently?
At the same time, Australia, Ireland, Spain, Canada, and
the U.K. all have higher or comparable rates of home ownership
to the U.S., but these countries provide far less government
support. In fact, the U.S. is unique in that it provides
preferable tax treatment for owner-occupied housing and it uses
all three types of Government support: support of mortgage
institutions or guarantee programs, mortgage insurance,
mortgage guarantees, and Government-sponsored mortgage
enterprises.
How did they achieve those rates of home ownership without
the Government subsidies or the types of programs that we offer
here in the U.S.?
In addition, some of those same jurisdictions have far
stricter underwriting standards for loans and a limited number
of mortgage products available to borrowers, with arguably less
preferential terms, but still maintain high home ownership
rates. How do we reconcile that paradox?
These are just a subset of the issues we seek to explore
with our witnesses today as we learn more about our
counterparts to the north and abroad and how they deal with
housing finance and confront the challenges and asset bubbles.
I welcome our witnesses' insights and perspectives on this
pressing issue and gathering what we can from other nations'
experiences. Thank you all.
Senator Corker.
STATEMENT OF SENATOR BOB CORKER
Senator Corker. Well, thank you, Mr. Chairman. I very much
appreciate your working to cause this meeting to take place.
I want to thank our witnesses, who are outstanding. And,
you know, the fact is that this year we are probably not going
to do anything as it relates to housing finance, but next year
we probably will, and I think understanding what has worked and
what has not worked in other places will be helpful. I think a
lot of times we have these myths or these built-in issues into
the DNA here as it relates to housing finance, and sometimes
looking in other places we can learn from that.
So I very much appreciate you being here today. I know that
we are at the wind-down and there is not a lot of activity as
far as people thinking about policy. But this will be very,
very helpful to us as we move ahead this next year, and I thank
all of you for coming, and I certainly look forward to the
Chairman introducing you.
Chairman Bayh. Thank you, Senator Corker.
I am going to ask that the introductions of our three
witnesses be included in their entirety in the record. You all
have such great experience and so many credentials, I am not
going to take your time by reading them all. I will just kind
of hit the highlights starting from our perspective with you,
Dr. Lea, and then moving to the rest of the panel.
Dr. Michael Lea is the director of the Corky McMillin
Center for Real Estate at San Diego State University. I have
already just mentioned that Dr. Lea is an international
authority on housing and mortgage finance and has published
over 75 articles and book chapters, including the editing and
coauthoring of an influential World Bank publication on
emerging market housing finance in 2009.
I am sure your book went higher on the Amazon scale than
mine did, Doctor.
He has over 25 years of financial services industry
experience, including more than 18 years of international
advisory work in 28 countries spanning six continents. He has
taught at Cornell University, San Diego State University, the
University of California-San Diego, and the Wharton
International Housing Finance Program at the University of
Pennsylvania. Wharton is well represented here today. He
receive his Ph.D. in economics from the University of North
Carolina at Chapel Hill.
Welcome, Dr. Lea.
Next we have Dr. Susan Wachter--I hope I pronounced that
correctly, Doctor--the Richard B. Worley Professor of Financial
Management, Professor of Real Estate and Finance, codirector at
the Institute for Urban Research, the Wharton School,
University of Pennsylvania. Dr. Wachter is codirector and
cofounder of the Penn Institute for Urban Research, has served
as president of the American Real Estate and Urban Economics
Association, and is coeditor of Real Estate Economics. She was
appointed Assistant Secretary for Policy Development and
Research at HUD and served from 1998 to 2001, where she was
principal adviser to the Secretary, responsible for national
housing and urban policy. Dr. Wachter received her B.A. from
Harvard College, which in our part of the country, Doctor, we
refer to as the Indiana University of the East.
[Laughter.]
Chairman Bayh. And her Ph.D. from Boston College. Welcome,
Dr. Wachter.
Next we have Alex Pollock, Resident Fellow of the American
Enterprise Institute. Mr. Pollock joined AEI in 2004 after 35
years in banking. He was president and chief executive officer
of the Federal Home Loan Bank of Chicago from 1991 to 2004. He
is also the author of numerous articles on financial systems
and the organizer of the ``Deflating Bubble'' series of AEI
conferences. He is a director of the Chicago Mercantile
Exchange--you employ many people in my State, which we
appreciate, Mr. Pollock--the Great Lakes Higher Education
Corporation, the International Housing Union for Housing
Finance, and the Chairman of the Board of the Great Books
Foundation. Mr. Pollock is a graduate of Williams College, the
University of Chicago, and Princeton University. Welcome, Mr.
Pollock.
Dr. Lea, why don't we begin with you. Just as a rule of
thumb--and I do not intend to enforce this strictly, but if you
have got a lengthy statement, if you could kind of summarize it
in 5 minutes or so, give or take, and then we could submit the
rest to the record. And as I said, if you go over a little bit,
that is not a big deal. But if you can kind of keep it in that
ball park, that would be great. And then we will go to a round
of questions after all three of you have finished your
statements.
STATEMENT OF MICHAEL J. LEA, DIRECTOR, THE CORKY MCMILLIN
CENTER FOR REAL ESTATE, SAN DIEGO STATE UNIVERSITY
Mr. Lea. Great. Thank you, Mr. Chairman and Ranking Member
Corker and Members of the Subcommittee, who will see it in the
record, I guess. As you said, I am Michael Lea, and I am the
director of the Corky McMillin Center for Real Estate at San
Diego State, and as Mr. Chairman's introduction, I have had
extensive experience in working and doing research in
international mortgage markets now for more than 20 years.
I recently completed a comparative study of developed
country housing finance systems that is going to be published
by the Brookings Institution later this fall as well as a
comparative study of mortgage instrument design which was
released this week by the Research Institute for Housing
America. And I would ask that both of these papers be entered
into the record.
Chairman Bayh. Without objection.
Mr. Lea. Thank you.
I would like to start by looking at the U.S. owner-occupied
mortgage markets in an international context. Our market is
internationally unusual in several respects. First, the U.S.
has a more extensive role of Government in our mortgage market
than other countries. The U.S. Government backs over 50 percent
of the stock of mortgage debt and over 95 percent of the new
flow. Only Canada comes close, with approximately 50 percent of
its loans directly or indirectly insured by the government, and
about 25 percent of Canadian mortgage-backed securities have a
government guarantee. Japan is the only other major developed
market with a government security guarantee program, and the
Netherlands is the only other market with a government-backed
insurer. I did a study of about 11 or 12 major developed
markets for this work.
No other developed market has a Government-sponsored
enterprise, as you said earlier. No other market has
quantitative housing goals or CRA-type legislation.
The U.S. is also unusual in the preponderance of the long-
term fixed-rate mortgage and funding through securitization.
Currently over 90 percent of U.S. new originations are fixed-
rate mortgages, and in most years, they have a 70-percent
market share. The only other countries with predominant market
share in long-term fixed-rate mortgages are Denmark and France.
The dominant instrument in other countries is either an
adjustable-rate mortgage, such as Australia, Spain, or the
U.K., or a short- to medium-term fixed-rate, sometimes called a
rollover, mortgage with a longer amortization period, such as
in Canada, Germany, and the Netherlands.
Over 60 percent of U.S. mortgages have been securitized and
over 90 percent of current originations are funded through
securitization. Internationally, Canada, Spain, and the U.K.
have funded approximately 25 percent of the mortgages through
securitization. In other countries, that markets share is quite
less.
The predominance of fixed-rate mortgages and securitization
in the U.S. is causally linked. Experience has shown that
capital market financing is necessary to manage the risk of
such mortgages. Their dominance is both a function of and a
rational for Government involvement. The Government effectively
subsidizes fixed-rate mortgages through the Government-
sponsored enterprises and Ginnie Mae, the guarantees for which
reduce the relative cost of this instrument. Investors in
fixed-rate mortgages like Government guarantees so they do not
have to worry about credit risk, only the underlying cash-flow
risk caused by long amortization and frequent prepayment.
Thus, supporters of Government-sponsored enterprises argue
that Government guarantees are needed to continue offering the
fixed-rate mortgage. Without such guarantees, fixed-rate
mortgages, in my opinion, would still exist but they would be
more expensive and there would be a smaller market share.
What has been the result of these policies? The U.S. does
not have a higher home ownership rate than in many other
countries, as you indicated in your introduction. In my survey
of 11 major developed markets, the U.S. was in the middle. The
U.S. does not have a deeper mortgage market, either. A number
of countries have higher ratios of mortgage debt outstanding to
GDP. The U.S. market was unequivocally the worst-performing
market during the crisis, with significantly higher rates of
default and foreclosure.
There are many factors contributing to its poor
performance, but the role of Government lending incentives and
the crowding out of lower-risk lending by Government entities
are significant contributors.
So what can we learn from the experience in other
countries? The role of Government in fostering home ownership
through tax incentives and lending programs has not resulted in
higher rates of home ownership, rather contributed to a
pronounced boom and bust that continues to plague the economy.
International experience suggests that sustainable home
ownership and mortgage indebtedness can be achieved without
such a large role of the Government.
What can replace the Government-dominated funding model
that now characterizes the U.S.? The Danish model offers
several areas for improvement. The Principle of Balance results
in a one-to-one correspondence between a mortgage loan and a
bond that finances it. If mortgage rates fall, the borrower can
refinance, as in the U.S. today. If interest rates rise, the
borrower, through their mortgage lender, can repurchase the
bond at a discount and cancel the mortgage. In this way the
borrower can reduce debt and, therefore, the likelihood of
negative equity in a rising interest rate environment.
This feature could also reduce the significant extension
risk that mortgage-backed security investors face in the U.S.
today. With rising rates, the effective maturity of mortgages
is going to be rising over time.
The highly efficient Danish mortgage market is funded
through corporate bonds in which the credit risk stays on the
balance sheet of the lender, thus aligning incentives. The
Danish model could be implemented initially by Fannie Mae and
Freddie Mac, ultimately transitioning to a private model.
The Canadian-European combination of the rollover mortgage
and covered bond financing has desirable characteristics as
well. For example, a 5-year fixed-rate mortgages with a 30-year
amortization provides significant, though not complete,
insulation of the borrower from interest rate risk,
particularly given the fact that the average homeowner moves
every 5 to 7 years here in the U.S. A shorter fixed-rate period
reduces the risk for the lender and investor and will result in
lower relative mortgage rates.
A key characteristic of this model is the ability of
lenders to charge prepayment penalties during the fixed-rate
period. The penalties allow lenders to issue very simple bullet
bonds or fund the loans through swap deposits. While prepayment
penalties got a bad reputation during the subprime lending
crisis here, they do serve a valuable function and are common
outside the U.S.
In conclusion, I believe there is much the U.S. could learn
from international experience, and I look forward to your
questions. Thank you.
Chairman Bayh. Thank you very much, Dr. Lea.
Dr. Wachter.
STATEMENT OF SUSAN M. WACHTER, RICHARD B. WORLEY PROFESSOR OF
FINANCIAL MANAGEMENT, PROFESSOR OF REAL ESTATE, FINANCE, AND
CITY AND REGIONAL PLANNING, THE WHARTON SCHOOL, UNIVERSITY OF
PENNSYLVANIA
Ms. Wachter. Chairman Bayh, Ranking Member Corker, thank
you for the invitation to testify.
The United States belongs to a group of countries that
suffered particularly severe recessions driven by sharp housing
price crashes. Other countries in this category include the
United Kingdom and Spain. On the other end of the spectrum are
countries where home prices merely leveled from 2007 to the
present, resulting in no or mild recessions. This category
encompasses Canada, Australia, and Germany. Denmark lies
somewhere in the middle, with a late bubble and current
downturn. By comparing these two groups, we can investigate
what causes and what prevents housing bubbles and financial
crises. In a forthcoming paper with colleagues, cited in my
written testimony, we conduct just such an investigation, and
we find that two institutional differences separate these
groups: the role of mortgage insurance and the strictness of
regulations countering the market's tendency toward procyclical
behavior.
No country better exemplifies this procyclicality in
housing and mortgage markets than the United States. With
economic growth and low interest rates coming out of the
recession of 2000-2001, mortgage lenders and securitizers
increased lending and competed for market share among
borrowers. When the available market was satiated, they
expanded the market by lowering their standards. Eventually,
borrowers found themselves with too much debt to repay, and the
downward spiral of foreclosures, defaults, and home price
declines resulted in the crisis we have today.
While lending standards deteriorated, the extent to which
this was occurring was unknown due to information opacity. I go
through a short description of what happened in the United
States to compare it to other countries.
Contrast this experience to that of Canada, where
regulators mandate that all high loan-to-value mortgages must
be covered by mortgage insurance. This practice has not
inhibited Canada from achieving levels of home ownership on par
with those of the U.S. at their peak in 2004. Canada and in
this period Australia, which also shows a high rate of home
ownership, relied on mortgage insurers as a ``third-party
regulator'' with the result that mortgage lending standards did
not deteriorate and housing prices did not collapse. Mortgages
in Australia and Canada were and are typically short-term
variable rate, or in the case of Canada, rollover, and were
originated and to a large extent held in portfolio by banks.
Both countries avoided recessions, home ownership, as I said,
has been maintained at high levels, and their banking systems
have been able to continue lending as the crisis has caused
financial systems in other countries to stop functioning.
The structure of the dominant mortgage product is also
critical to preventing procyclicality. Most countries rely on
adjustable-rate mortgages or rollover mortgages provided by
banks and held in bank portfolios. The U.S., Denmark, and to a
lesser extent Germany are the three notable exceptions,
favoring fixed-rate mortgages or relatively long-term fixed-
rate mortgages. ARMs place the interest rate risk on the
borrower, who is not well suited to bear this risk. When
interest rates rise, borrowers have difficulty making payments
and may be forced to default. ARMs are also less conducive to
systemic stability, as exhibited during the current economic
crisis here and elsewhere. During the housing bubble,
securitizers' appetite for market share drove them to
underwrite riskier adjustable-rate mortgages from less
creditworthy borrowers. The U.K. and Spain also relied on ARMs
with deteriorating lending standards. All countries with ARMs
saw their lending dry up during the credit crunch with
borrowers not able to refinance even though it was assumed that
refinancing would always be possible. With ARMs that need to be
repaid or refinanced, the illiquidity of the system may be
transformed as in these countries into a solvency or
foreclosure crisis.
Building a system around the fixed-rate mortgage requires a
secondary market. In my written testimony, I go into more
detail as to why.
Unlike the private label securities of ARMs, securitization
allows a fixed-rate mortgage that would otherwise not exist. In
Germany, a secondary market exists in the former of covered
bonds, identified as ``Pfandbriefe,'' that are secured by
standardized mortgage loans, which the quality of the
standardized mortgage loans was not allowed to be undermined
over time.
But without proper regulation, covered bonds can get a
country into trouble. German regulators ensure that investors
get periodic updates on the state of the collateral securing
their covered bond, and they do not allow covered bonds to be
secured by loans with an LTV ratio above 60 percent. Unlike in
the U.S., these regulations were not eroded during the housing
bubble. Denmark also relied on covered bonds and had similarly
stringent regulations until recently. When Danish legislation
moved the system toward interest-only mortgages, the market
joined the housing mania and developed a late bubble that
subsequently deflated, causing the current recession in
Denmark. Similarly, Spain used covered bonds extensively, yet
they did not have fixed-rate mortgages; they used covered bonds
to finance adjustable-rate mortgages. The Spanish banks, the
savings banks, cajas, securitized ARMs through cedulas in an
effort to generate fees and gain market share, generating a
bubble and crisis that is severe, with Spain now suffering 20
percent unemployment. In the face of rising prices, it is
tempting to lower lending standards, as occurred in these
countries, contributing to procyclicality.
Most countries do have significant involvement of
governments in housing and mortgage markets. Now, Canada, as we
have just heard, provides catastrophic mortgage insurance to
most of its mortgage market. In other countries, when the
housing market is in crisis, when the entire system is in
danger, there is a rescue. The British rescue of Northern Rock
preceded the American bailouts; the Spanish government has
intervened to protect the cajas and their covered bonds. To
prevent a foreclosure crisis from driving an economy into a
severe recession or depression, governments will intervene;
thus, it is necessary to regulate the housing market before it
reaches the crisis stage. The taxpayer owns the tail risk.
Rather than raise lending standards after the fact, we can
prevent the problems of moral hazard, shrinking equity, and
bailouts by maintaining standards and transparency.
In closing, the clearest difference between the U.S., the
U.K., and Spain on the one side and Australia, Canada, and
Germany on the other side is the stability of regulation. The
first group allowed lending standards and capital requirements
to decline, stoking the procyclical behavior that created a
housing bubble and economic crisis, while the latter group
maintained rules in the face of market pressure.
Thank you.
Senator Corker [presiding]. Go ahead, Mr. Pollock.
STATEMENT OF ALEX J. POLLOCK, RESIDENT FELLOW, AMERICAN
ENTERPRISE INSTITUTE
Mr. Pollock. Thank you, Mr. Chairman.
As you mentioned in your opening comment, it is without
doubt the case that it is very useful to examine American
housing finance in an international perspective. When we do, we
discover one thing unique in the world about American housing
finance, and that was the dominant and disproportionate role
played by Government-sponsored enterprises--that is, Fannie Mae
and Freddie Mac.
With Fannie and Freddie so prominent, many Americans,
including Members of Congress, including the two gentlemen I
had lunch with today, thought that America had the highest home
ownership rate in the world. As you have pointed out, we did
not and we do not.
In my written testimony, there is a table of comparative
home ownership rates. Michael has 11; I have 26 advanced
countries in my table, and I think it is about as up to date as
it can be. The U.S. ranks 17th in this list among advanced
countries, or about two-thirds of the way down the list, in
home ownership. And as I say, that table is in my written
testimony.
Many countries achieve home ownership levels as high or
higher than ours with no GSEs. Various housing finance systems
operate without tax deductions for the interest on home
mortgages, without our highly unusual practice of making
mortgages into nonrecourse debt, and without government CRA-
like mandates to make riskier loans, without 30-year fixed-rate
loans, and with prepayment fees on mortgages.
Of course, as bubbles and busts in these other countries
show, you can also get in trouble with different systems. That
is a general rule, I take it, of finance. You can always get
into trouble in finance.
The better credit performance of Canada and Canadian
housing finance has been well known, and, indeed, Canada has
mortgage delinquencies which are a small fraction of ours.
Canadian mortgage lenders have full recourse to the borrower's
other assets and income, in addition to the security interest
in the house. The fact that there is no tax deduction for
interest probably increases the incentive to pay down the debt
over time. Most Canadian mortgage payments are made through
automatic debit of the borrower's checking account and can be
matched to the frequency and timing of the paycheck. It is a
technical but I think very important point in terms of the
behavior of borrowers.
With this relative credit conservatism, as has been pointed
out, Canada's home ownership rate is 68 percent compared to 67
percent for us, and Canada does have a government body to
promote housing finance, which has a very substantial role, as
my colleagues on the panel have said, the Canada Mortgage and
Housing Corporation, or CMHC. But at least CMHC's status,
unlike the American GSEs, is completely clear and honest. It is
a 100-percent government-controlled corporation. Its government
guarantee is completely explicit. It provides housing subsidies
which are on budget and have to be appropriated by the
Parliament.
Canada in this respect, therefore, looks superior to the
U.S. in candor, as well as credit performance. It has, however,
had a big run-up in its house prices over the last decade, and
this is shown in my written testimony. In response to this,
Canadian regulators have taken actions to decrease the maximum
loan-to-value ratios on some classes of mortgages, and such
countercyclical movements in LTV limits, in my opinion, are an
excellent idea and are, indeed, necessary to moderate the
inevitable cycles in real estate credit.
As has been discussed, the most perfect housing finance
solution in theory, which also functions very well in practice
in an admittedly small country, is the housing finance system
of Denmark, which has been admired by many observers. The
interest rate and prepayment characteristics of long-term
fixed-rate loans in the system are passed entirely on to
investors in Danish mortgage bonds. But at the same time, there
is a total ``skin in the game'' requirement for credit risk.
The lending mortgage banks retain 100 percent of the credit
risk of the loans. Deficiency judgments, if foreclosure on a
house does not cover the mortgage debt, are actively pursued.
Some years ago, before the fall of Fannie and Freddie, I
participated in an exchange with the Association of Danish
Mortgage Banks. The idea was that they explained their bond-
based and skin-in-the-game-based system to me, and I explained
the American GSE-centric system to them.
When I had finished my presentation, the CEO of one of the
leading Danish mortgage banks said this: ``In Denmark we always
say that we are the socialists and America is the land of free
enterprise,'' he said. ``Now I see that when it comes to
mortgage finance, it is the opposite!'' And, indeed, I think
that is an insightful statement.
In my written testimony, I also discuss some other
countries, including two ideas from Germany worth pursuing, one
being covered bonds and the other being an emphasis on savings
as part of housing finance, which has not been mentioned yet,
Mr. Chairman. We need to rediscover the idea of savings as part
of what we are doing in housing finance, as the old name
savings and loan would indicate.
Well, America's GSE-centric housing finance system has
collapsed, with massive taxpayer expense, as did the former
thrift-based system which preceded it.
The international perspective suggests that there is every
reason to think broadly about how to develop a better, post-GSE
U.S. housing finance system for the future.
Senator Corker. Thank you all for your testimony, and I
think, to sort of shorten the chase here, if you will, Mr.
Pollock, why do we not just start with that and have each of
you, if you will, describe without the built-in DNA that exists
around what we have in our own country, based on what each of
you know about other countries and what you have seen here, if
we were--because that, I think, is where we are going to try to
go this next year--if we were going to design a housing finance
system that worked in this country, taking into account the
cultural aspects over the last 50 years that have developed
around housing, what would it be?
Mr. Pollock. Do you want me to start, Mr. Chairman?
Senator Corker. Yes.
Mr. Pollock. In my opinion, it would have a much bigger
role for a truly private market. That is to say, the vast bulk
of the residential market, which is the middle-class what we
call conforming or prime mortgage market of the size that the
vast bulk of the population borrows to buy houses that are in
the middle of the distribution, would be a fully private
market.
I have the notion that among the participants in this
market would be the privatized parts of Fannie Mae and Freddie
Mac in the future, when they leave behind their bankrupt old
business. But that needs to be a private market, and I think on
that basis it would work well and it would succeed in
delivering a better resource allocation that is not warped and
distorted by all kinds of government subsidies and guarantees.
For that part of the system which we would choose to
subsidize or to do credits which a market would not do, I think
that should be a purely and explicitly government activity, as
it is in Canada, where the subsidies, instead of being hidden
in GSEs and be able to allow those GSEs to exert significant
political clout, those subsidies and nonmarket financings
should all be explicitly in the government, have to be approved
and appropriated by the U.S. Congress. So in that way, I think
we would look more like other countries and we would have a
superior economic model.
Just two other points. I think that it does make sense to
think about covered bonds as an alternative financing. As my
colleagues have pointed out, if you want to have fixed-rate
mortgage loans, you have to have a bond market financing. You
cannot finance long-term fixed-rate mortgage loans on a deposit
basis, and in this country the banks are not big enough to
finance the whole mortgage market anyway. And covered bonds, I
think, make an alternative which should be explored. That
alternative needs to have a statutory basis so the bond holders
are truly given certainty about their collateral. And I agree
with Dr. Wachter that the loans in such covered bonds should be
conservatively underwritten loans.
And then finally, as I said, we need to rediscover savings
and an emphasis on saving to enter into the housing market and
paying down the mortgage as a source of long-term savings, so
that in the very old fashioned but correct idea you actually
end up owning the house as you get older.
Senator Corker. What would the government subsidy that you
are talking about that would be transparent, that subsidy would
be directed at what?
Mr. Pollock. Well, Mr. Chairman, of course, it would be
directed at whatever the Congress decided it would be directed
at, but typically----
Senator Corker. But you are developing this----
Mr. Pollock. ----but typically low-income households who
are trying to enter into home ownership but still have a very
good chance of performing successfully on the debt which they
undertake. Certainly, this system has to have, or should have
as part of what we do in the future, very clear, simple, and
transparent information provided to borrowers about the credit
commitments they are making so they really understand the
commitments they are signing up for and they can underwrite
themselves, as I like to say. It is much more important to
underwrite yourself as a borrower, can I do this, than for
somebody else to underwrite you.
And you, of course, never do anybody a favor by making them
a loan they cannot afford, whether you are the government or
whether you are a private factor, and we want to avoid that.
Senator Corker. Generally speaking, do other countries--are
there a lot of other countries around the world that have
subsidies for----
Mr. Pollock. Yes.
Senator Corker. ----for lower-income citizens?
Mr. Pollock. Yes, in advanced countries.
Senator Corker. And they are interest rate subsidies, is
that what you are talking about?
Mr. Pollock. I think they are typically--actually, Michael
would know this better than I, but I think they are typically
credit availability programs or--and there are often rental
subsidies, as well. A lot of countries use these subsidies,
including Canada, as a rental program, government program for
low-income housing.
Senator Corker. And for the middle- and upper-income
citizens, would there still be--would you, if you could design
it, still focus on long-term fixed-rate mortgages, or would you
just let the market determine that----
Mr. Pollock. I would definitely have long-term fixed-rate
mortgages in a system, because I think they would naturally
evolve. But I think Dr. Lea is right. They would be a smaller
part. They would probably be somewhat higher priced. And houses
would be less expensive because you know that the most
fundamental proposition in all economics is that not only
lunches, but nothing is free, and all of the subsidies we put
into housing finance merely go to make houses more expensive.
So the home buyers do not win in the end.
Senator Corker. Dr. Wachter.
Ms. Wachter. I agree with much of what Dr. Pollock has
said. I do want to take a small exception to the last comment.
While it is true that housing subsidies do raise prices some
places in the United States, not all throughout the U.S.
Housing is elastically supplied in much of the U.S., and in
that case, it does not have that impact.
But I specifically do agree with the need for subsidies and
the need for them to be explicit. I also, as you know from my
comments, I do think it is extremely important, particularly at
this time, for there to be the necessary institutions to
support the long-term fixed-rate mortgage. We are at a point of
historically low interest rates. If interest rates were to
rise, let us say, 20 percent, 30 percent, in a world with an
adjusted-rate mortgage, that would be equivalent to a 20, 30
percent rise in mortgage payments, which could create a crisis
of similar dimensions of the crisis that we had if across the
board mortgages went up that much, and perhaps in some cases
doubled. If rates doubled, this would basically take people
from, let us say, 30 percent of their income to 60 percent of
the income. It is for this reason that countries that have
reliance on adjusted-rate mortgage are attempting to create
fixed-rate mortgage and move away from adjusted-rate mortgages.
Also, there is a problem that the U.K. has spoken of, and
it is in the Miles report, of some hesitancy to use monetary
policy when necessary because of the fear of rising interest
rates and what it would do to destabilize not only individual
homeowners, but indeed the entire economy.
So we are fortunate in having a fixed-rate mortgage. What
we are not fortunate, obviously, what cratered our system was
the deregulated private-label securitization that undermined
lending standards. That happened nowhere else. In fact, Canada
was considering a subprime mortgage market. They came to me,
among others, to write a report to advise on that. This was in
2004. Many people submitted a report--I did--and advised
against their moving to allowing a subprime mortgage market.
Canada, as we have heard, does have great involvement in
the mortgage market. Specifically, it has also recourse
mortgages. Recourse mortgages really could not work in the
United States. Because of our bankruptcy law, that is not
really an option for us.
And so we have for every reason, then, to be even more
determined and careful in our regulation of our mortgage system
so that we do not have crises which end up being taxpayer
funded.
So let me go back to your question of what, then, would we
take from other systems. Systems of both Denmark and Germany
have much in them for us to model, particularly, as Dr. Pollack
has said, they have in their securitized--and they use covered
bonds, but, in fact, covered bonds when regulated well are not
so dissimilar from mortgage-backed securitization that is
regulated well. These securities that go into the covered bonds
are, indeed, transparent. They are standardized. They are--
information on them is maintained over time.
This is significantly monitored, and it is key if we are to
have securitization that we monitor, from my perspective, what
goes into the securitized entities for housing finance, because
capital markets will always be subject to shocks. There is no
way of stopping that. The shocks will then be transferred
through the securitization to the housing market. If at the
same time in a procyclical way the securitization standards are
undermined, then we will, of course, have what we have today
and it will be recurrent.
So to avoid both of these problems, I absolutely am in
favor of a fixed-rate mortgage. By the way, if you just have
adjusted-rate mortgages, you are basically reliant on your
banking system and banking systems across the world have
cratered, as we are well aware. Japan has had, through a kind
of savings and loan crisis which got even larger, a basic real
estate crisis beyond that, two decades of slow to no growth.
So a banking system mortgage-based finance does not prevent
crises, either. In both cases, transparency, risk monitoring by
the private sector as well as the public sector, is necessary.
Senator Corker. So Mr. Pollock mentioned, I think, that the
only involvement government had in his model would be on the
subsidizing lower-income portion. As it relates to fixed-rate
mortgages from your viewpoint, would that also--would you have
government involvement, and middle- and upper-income loans
also?
Ms. Wachter. Absolutely, as there is in Canada. There would
be, as in Canada, a provision of catastrophic mortgage
insurance that would be priced. It would be explicitly priced.
Senator Corker. And how does the insurance work in Canada?
Ms. Wachter. I think perhaps Dr. Lea might be able to give
us more details on how it works, but my understanding is that
both the private insurers, of which there are two, do have a
backstop of catastrophic insurance if there is a crisis, as
well, of course, as the mortgages that are insured through
CMHC.
Senator Corker. And they are insuring the mortgage, but not
the entity that actually----
Ms. Wachter. And that is exactly where I would go. I would
go to issuers of mortgages that are securitized that have a
wrap on the mortgage-backed securities, but the first loss
would be the private equity which would be at the risk and the
companies themselves would be absolutely at risk.
It would seem to me you could also have, although you are
never going to get away from the risk of catastrophic
insurance, you would also potentially have companies which are
issuing mortgages, securitized, without a wrap. But that would
require, from my perspective, that the mortgages in these
securities be well understood, well vetted, tracked real time
for their potential risk.
Senator Corker. Why do you not go ahead and jump in, Dr.
Lea.
Mr. Lea. OK. Several comments and responses. In my view, an
ideal housing finance system should have diversity in both
instruments and in funding sources. I think a model that has
almost all of its loans being fixed rate has problems and
issues because of the risks associated with that to investors.
I would also point out, in a rising interest rate environment,
affordability problems are going to be exacerbated by the
inflation premium that is built into long-term fixed-rate
mortgages.
Likewise, as Dr. Wachter says, I do not think it is wise to
have an entirely adjustable rate system where you have
potentially significant payment shock for a wide part of the
population. Rather, I would like to see some of both, where
borrowers and lenders self-select with regard to the interest
rate risk carrying capacities of the different borrowers.
For example, in Canada, they have this rollover mortgage.
While the typical fixed-rate term is 5 years, so this would be
a 30-year amortization mortgage but typically fixed for 5
years, the borrower can select between a 1-year, a 3-year, a 5-
year, or in some cases even a 10-year fixed rate period. So
that does allow the borrower to manage interest rate risk to a
degree, because if they think rates are high and going to fall,
then they can go into a shorter-term fixed rate. If they think
rates are low and going to rise, they would pick a longer-term
fixed rate.
I would also point out in the adjustable rate world, such
as in the U.K., talking to the Council of Mortgage Lenders, for
example, they credit the adjustable-rate mortgage for actually
reducing defaults during the crisis because interest rates and
payments have come down quite a bit. This is also the case of
Australia. Though I fully agree with Dr. Wachter that we are
now at historic lows and we are going to see significant
increases going forward.
A couple other comments. With regard to subsidy, I just do
not think it is generally a good idea to subsidize interest
rates or to push the market toward particular products. I think
from the subsidy kind of standpoint, what we should do is focus
on affordability. I would note that both Australia and Canada
have first-time homebuyer tax credit programs. They do not have
the mortgage interest tax deduction. The mortgage interest tax
deduction does very little to stimulate home ownership. In
fact, most of its effect is as a regressive subsidy to higher-
income people as well as being capitalized in the house prices.
And so if we are talking about an ideal world, I would
gradually phaseout home mortgage interest deduction, but I
would put in its place some form of first-time homebuyer tax
credit which is targeted toward first-time buyers. It could
also be targeted toward lower-income.
I also point out that other countries do subsidize rental
housing more extensively than we do. In most countries that I
looked at, the types of voucher programs that assist lower-
income renters are entitlements. You qualify, you get it, as
opposed to the U.S. where they are still effectively rationed
and there is excess demand for those kinds of subsidies.
I agree with Dr. Wachter on the efficacy of the mortgage
insurance. I think that using mortgage insurance initially
through private mortgage insurers and having the government
insurance backstop is a good idea. In Canada, the government
provides a 90 percent backstop, catastrophic backstop, to
private insurers. That was done primarily to try to level the
playing field between the government insurer and the private
insurers.
I would disagree with one thing with Dr. Wachter, though I
have not looked at this from a legal standpoint, but the
contention that recourse is impossible in the U.S. Recourse is
practiced in a number of States in the U.S. Some lenders are
more aggressively going after deficiency judgments. And it is
an important, I think, incentive mechanism for avoiding things
like strategic default. And every other developed country has
recourse mortgages and lenders do routinely go after deficiency
judgments, and I think that also curbs over-indebtedness and
speculative behavior on the part of borrowers. And so I would
submit that in the future, we should not rule that out. I think
that that is an important part of any legal system underlying
the mortgage market.
Senator Corker. What is it about the--and just 1 second,
Mr. Pollock, but what is it about the bankruptcy laws that make
the recourse issue not practical? I thought it was more the
State Constitutions----
Ms. Wachter. State Constitutions are actually the big----
Senator Corker. So it is really not the bankruptcy laws?
Ms. Wachter. Well, the biggest--yes, the bankruptcy adds to
it in the sense that if the borrower has an option to go into
bankruptcy, then repaying through income, for example, may not
be viable. In Denmark, actually, wages are garnished, and I do
not think that that would be viable if the borrower was in
bankruptcy, at least in that period.
Senator Corker. Mr. Pollock, you wanted to say something?
Mr. Pollock. Thank you, Mr. Chairman. I just wanted to add
three quick things. I hope it was clear in my comments, but in
my ideal mortgage system for the U.S. going forward, there
would be no GSEs.
Senator Corker. I kind of gathered that.
Mr. Pollock. I just wanted to make that explicit.
Senator Corker. Yes.
Mr. Pollock. You would either be private or you would be
the government, but you could never be both at the same time. I
think that is an important principle.
A second comment is that there is also a risk for the
borrower with fixed-rate mortgages, and that is you have a
fixed-rate mortgage at some rate and rates go way down because
we are having a recession, unemployment is high, and you cannot
refinance for credit reasons, which is the situation of many
people now. And the fixed-rate mortgage, in fact, puts you in a
terrible place in that situation. So we need--there is nothing
you can do that takes away all risks from everybody, and there
are risks in that, as well.
Finally, just on the fact of how Canada works, one of the
things I would not copy is the Canadian mortgage insurance. The
overwhelming amount of Canadian mortgage insurance, and there
is about 470 billion Canadian dollars of mortgages insured out
of a total market of about 950 billion Canadian dollars or so,
so that is half of the market, is provided directly by the
Canada Mortgage and Housing Association, which is the
government and it, in effect, guarantees 100 percent of the
mortgage. There is no private capital there. There is just the
taxpayer guaranteeing it. In my judgment, that is a bad idea. I
would not do it.
There are Canadian critics who think that that pushing of
credit, of mortgage credit, is contributing to the rise, which
is quite dramatic if you have a chance to look at the graph in
my testimony, in my written testimony, and they think that they
may have a bubble. They say--some people in Canada say they
have a bubble and attribute this very heavy intervention as
part of the cause. That is obviously debatable. But it is clear
that in the Canadian system, for about half of the market,
there is a direct taxpayer guarantee with no private equity in
there, and the banks who then hold these insured mortgages get
extremely low capital requirements for the mortgage. So the
capital is not in the bank, either, when they are holding the
mortgages. And, as I say, that is a part of what our Northern
neighbors do that I would definitely not copy.
Senator Corker. Dr. Lea, what is required in Canada to
receive that insurance, meaning what type of oversight and
standardization has to exist for those originating these loans
to be able to secure this government insurance guarantee?
Mr. Lea. Well, first, if you are a bank or regulated
lender, you have to have insurance if the loan is over 80
percent loan-to-value ratio. So that then brings a mortgage
insurer, either government or private, into the picture and
they will set the standards for what they will insure.
Senator Corker. And in a collapse, I mean, one like we have
had here in our country, very quickly, those entities would be
out of business, is that correct? I mean, in a crisis like we
have had. That is an interesting thing for episodic-type, just
episodes of people failing, but when you have a systemic crisis
like we have had, basically, those are wiped out pretty
quickly, right?
Mr. Lea. Well, not necessarily. I would point to the fact
that our private mortgage insurers still exist and they have
basically survived. We have had one that has ceased writing new
business, but they are still in business and several have
raised new capital.
They, I think, benefited from the fact that a lot of the
riskier mortgages, A, they did not insure them, did not meet
their standards, and B, a lot of lenders tried to circumvent
the insurance by creating the so-called ``piggyback loans,''
80/20 type of loans so that they could avoid charging borrowers
mortgage insurance, and that also was where a lot of the
riskier loans went.
And the third thing I would say is that if you had the
universal, everything over 80 percent, then you are spreading
your risk out, and one of the principles of insurance is to try
to get more and more diversification. And absent a true
systemic collapse--now, certainly you can come up with
scenarios in which the insurance capital will not be
sufficient, but insurance capital is different than banking
capital in the sense that it is much more risk-based and you
cannot pay out dividends as long as your risk ratios are at
particular levels. So I think that, actually, from a capital
adequacy standpoint, insurance models may be somewhat better
than bank capital models.
Senator Corker. So then back to this sort of standard
issues, other than the mortgage insurance, what is it that
happens in Canada to be able to get, if you will, that
government insurance? What kind of standardization? What kind
of oversight?
Mr. Lea. Well, again, the mortgage insurers are regulated--
--
Senator Corker. So it is really the mortgage insurer that
is making that determination.
Mr. Lea. Absolutely.
Senator Corker. OK.
Mr. Lea. Absolutely. The bank----
Mr. Pollock. But Michael, you would have to say the
overwhelmingly dominant mortgage insurer is the government of
Canada----
Mr. Lea. Correct----
Mr. Pollock. ----through CMHC.
Ms. Wachter. And two other companies----
Mr. Pollock. Yes, but they have----
Ms. Wachter. ----smaller, I agree----
Mr. Pollock. ----they have a very minor share of the
market. We are really talking about a government program.
Mr. Lea. So the government set the standards and----
Senator Corker. And are those standards stringently
enforced and----
Mr. Lea. As far as I know, yes.
Ms. Wachter. Absolutely.
Mr. Lea. They started to relax them a little bit during the
mid-2000s, kind of a boom period, and as they saw the markets
starting to weaken, they lowered the maximum LTV. They also
lowered the maximum term. They had been insuring out to 40
years. They moved that back to a maximum of 35. So they
definitely tightened as they saw the downturn coming.
Senator Corker. Dr. Wachter and Mr. Pollock, do you all
agree that the interest rate deduction does not stimulate, as
Dr. Lea has said, does not stimulate home ownership?
Ms. Wachter. I agree. I would like to go back to the--but
today, if you did withdraw the interest rate deduction, it
would be a problem in the state of today's market.
Senator Corker. Well, other than the rebellion that would
take place, you are saying--but expand. Tell me, in your
opinion, why it does not aid in home ownership or the
desirability of home ownership.
Ms. Wachter. The way we--at this stage, the way it is
structured, because many people take the standard deduction,
lower-income, middle-income households take a standard
deduction, we only have----
Senator Corker. So they never bump up against the actual--
--
Ms. Wachter. They never bump--almost 49 percent do not pay
taxes at all, so that you can see that the deduction is more
important for higher-income households----
Senator Corker. Mr. Pollock----
Ms. Wachter. ----who would own, also, and----
Senator Corker. And on that same note?
Mr. Pollock. Everything we do in housing finance, Mr.
Chairman, you have to think about the interaction of finance
and prices of the houses. Certainly, in an upper part of the
market, upper half or so, the prices reflect the deduction, and
I suspect if you took it away, you would not like the price
reaction, and in a situation when a lot of people are
underwater on their mortgages already, that gives you a real
transition problem to work on if you wanted to get to a state
of no interest deduction. We all know about politically how
hard that is, but there is also a price problem especially now.
Senator Corker. So, I mean, but from a standpoint of making
that transition, is that something that if one were to make
that transition over a decade, would that be so distortive that
it would hurt prices immediately?
Ms. Wachter. Yes. This is not the decade to do it. Housing
markets are too fragile. Perhaps 5 years from now, we could
reconsider, or 2 or 3 years. But at this moment in time,
housing markets are sufficiently fragile, they may start
declining again and setting up a spiral of declining prices,
increasing foreclosures, decreasing prices. We are not out of
those woods yet.
Mr. Lea. I would point out that the U.K. did, over a decade
time period, get rid of the mortgage interest deduction. They
started as the market was coming out of the early 1990s
downturn, which was a very severe downturn in the U.K. So I
agree fully with Dr. Wachter that this is not the time to do
it, but if we think 2, 3 years out of something like a decade-
long policy, what they did in the U.K. was starting to lower
the cap. We have a million-dollar loan cap now on deducting
interest. You start lowering that. You also can lower the
maximum marginal tax rate that you can take the deduction
against, so you shrink the absolute size of the deduction then
eventually have it go away. But it would have to be in a
recovered market before you would want to start eliminating
that.
Senator Corker. How do the three of you feel about
prepayment penalties?
Mr. Lea. How do what?
Senator Corker. How do the three of you feel about
prepayment penalties? In other words, in a normal, functioning
commercial market, if you have a 10- or 15- or 20-year fixed-
rate mortgage and you want to pay it off, you pay a penalty.
That accounts for the losses that the investor would have
because of the rate adjustment that would take place on the new
mortgage they might have to replace it with. How would the
prepayment penalty, should it come back, how would that affect
the housing market and people's mentalities as it relates to
longer-term mortgages?
Mr. Lea. Well, the countries where you have prepayment
penalties, you would not have it for a full 20-, 30-year term.
So typically, in countries like Canada and the Netherlands, it
is predominately with a 5-year or shorter fixed-rate period.
And so at the end of that period, then the loan rate is
renegotiated and you are free to pay it off in entirety at that
time. In Germany, you can go up to 10 years with a prepayment
penalty, but the law caps it at that, even if the actual
interest rate may be fixed for a longer time period. So it is
not for 20- to 30-year type times.
The second thing, I think that the market is a place for
both loans with and without prepayment penalties, and I think
borrowers can self-select based on the pricing of the loans,
because remember, if we do not have a prepayment penalty, as we
have in the U.S., there is a fee that all borrowers pay. It is
incorporated into the mortgage rate. There is an option premium
for the option the borrower has to have early repayment that
has mortgage rates to be higher than if you did not have that
option. So everybody is, in effect, paying it, whereas the
European view is that you benefit, you pay. So it is not a
socialized type of model.
I think there is a market for both and that allows
borrowers to self-select based on the initial rate in the
mortgage, what their expectations are, both for interest rates
and moving. And again, I think more choice is better. We should
not have a market that is all one or all of another.
Ms. Wachter. I agree. I think there should be a choice in
the prepayment penalty or not, and absolutely agree with Dr.
Lea that it is priced in. If there is no prepayment penalty,
then that is going to affect the payment.
I do also want to underline, however, that there is an
advantage for the overall economic and systemic stability to
having a preponderance of no prepayment penalty, and that goes
just to the point of Dr. Pollock. Today, if we had a
significant prepayment penalty, that would create an even more
severe problem for those who wish to refinance out of fixed-
rate mortgages into lower interest rate fixed-rate mortgages
today, helping out the overall economy. That is, there is an
automatic stabilizer in the ability to refinance when the
economy declines and interest rates decline if there is an
ability to refinance. Nonetheless, it should be priced. It is
priced and there should be both options.
Mr. Pollock. There is an economist at the World Bank who
has pointed out that in America, we have very high transaction
fees for refinances which function in a way like a prepayment
penalty. And another of the things we should think about in a
future housing finance system is instruments that reduce those
very high transaction costs as we churn fixed-rate mortgages.
That is a very high cost to consumers.
I agree, in a private system, which I would favor, you
would evolve mortgages with prepayment fees and mortgages
without. The ones with prepayment fees would have lower
interest, just like you have mortgages with up-front points you
pay and mortgages that are no-point mortgages. If you pay
points, you get a lower rate. It would work the same way and
the market would work out the balance. We have to make sure
only that the parties to the transaction understand what the
deal really is and then the market will sort out the
preferences of the various borrowers and lenders.
Senator Corker. What has been your experience over the last
20 or 30 years looking at markets where most borrowers have a
floating rate as opposed to a fixed rate? Over the course of
time, has the amount of interest that they have paid, how does
that compare to a fixed-rate market like the U.S.?
Ms. Wachter. Well, the dramatic issue is that over the 20
years, interest rates have fallen across the world. They have
fallen dramatically, seeing they were on average, in the study
that we have done of 15 countries over 1980 through 2000, they
fell from about 15 percent to 6, 7 percent. So in this scenario
of declining interest rates, an adjustable-rate mortgage is
perfectly safe. There have been very few countries that have
had adjustable-rate mortgages a large share of their system
that have faced a situation with rising interest rates. There
is one exception to that that I know of, and that is the U.K.
in the early 1990s.
Many, actually, developed housing markets have only, as Dr.
Lea has extensively written about, have only developed since
1980. So we do not really have a huge experience of a well
developed mortgage system, by that I mean a system where many--
where the preponderance of people do have mortgages and have
adjustable-rate mortgages in a world where there is a sharp
rise in interest rates. We simply have not seen that. As I
said, there was this exception in the 1990s in the U.K. The
U.K. did have a very well developed mortgage market and
entirely adjustable-rate mortgages and their banking system was
imperiled, as was the mortgage insurance system, at that point
in time as interest rates rose coming out of 1990.
Senator Corker. Any other comments here?
Mr. Pollock. I would comment on that, Mr. Chairman. There
was a time in the 1990s when I was refinancing my loan once a
year and it was much cheaper--U.S. specifically--how much
interest you pay on an adjustable rate versus a fixed rate.
That was much cheaper in that setting. And Chairman Greenspan
at the time got himself in trouble once for talking about how
much cheaper it would be for people to finance on adjustable
rates. But there are times when it is cheaper. In a market
where you have choices, it allows consumer borrowers to make a
risk-reward choice. As in other normal financial markets, you
have got purveyors of funds and takers of funds and they are
negotiating where they think the risks and rewards are.
For a long time, starting off, let us say, around 1950
until 1980, interest rates were rising. People who had
mortgages they took in the 1950s, if they were long-term
mortgages, or 1960s, did very well relative to floating rates.
Of course, the result of that was the failure of the entire
savings and loan industry and the difference got to be paid by
the taxpayers.
There is no way you can mechanically set up systems to
assure that they will not fail and get you in trouble, but I
think the more choices people can make in informed ways, the
better overall it will function, including the question of
trying to manage their total interest rate bill.
Ms. Wachter. If I could just quickly follow up, the fact
that we did have, of course, this major crisis, we were not the
only country, and many countries had similar crises, which has
led to the fact that banks do not make fixed-rate mortgages and
hold them in their portfolio going forward.
Senator Corker. In my previous life, I borrowed a lot of
money and it was just part of what we did in business. I can
tell you, there was no question a built-in mentality that if
you had a floating-rate loan, especially one that was recourse,
you know, most fixed-rate mortgages in the commercial sector
are nonrecourse, but usually floating-rate loans are not. They
are recourse. And so the mentality of having a recourse loan
and also knowing that that rate could change caused you to pay
that loan off as quickly as possible, and every cent, every
dollar you had that was extra was used to pay down that
mortgage. And so it is easy to see, certainly with the mortgage
deduction component that goes with it, that--I mean, we
basically incent people not to do that.
As you look at these other countries that have variable-
rate mortgages mostly, that have not gotten into the kind of
troubles we have, you know that part of the mentality in that
household is that if there is an extra dollar or two that
month, they are going to use it to pay the mortgage down
because it, in effect, is savings, right? I mean, that is the
same as savings and it is also deferring costs that are going
to occur down the road due to interest payments.
Ms. Wachter. I am certainly not disagreeing that in the
commercial sector, in your experience of the commercial sector,
but it is absolutely not the case that adjustable-rate
mortgages have stopped borrowers from not taking on new debt.
Of course, in the United States, the entire subprime market was
an adjustable-rate market. So the increasing debt over time in
this period from the late 1990s to 2006, at its height, was
refinancing in the adjustable-rate product.
Senator Corker. Yes?
Mr. Lea. In both Australia and the U.K., you did have very
high LTV lending, where people took on a lot of debt even with
the adjustable-rate mortgages. The one thing, though, that
exists is people, as you suggest, do tend to pay down their
debt more rapidly. I think that is in part due to the fact that
interest, again, is not tax deductible, so it pays to
essentially pay off that higher rate mortgage, for one thing.
The second thing is that, historically, both Australia and
the U.K. have kind of an administered rate system, so unlike
the U.S. adjustables, which are indexed to something like LIBOR
or a money market rate or 1-year Treasury rate, you have what
is called a discretionary ARM where the rate is set by the
lender for all borrowers at the same time. Now, the positive of
that is that lenders do tend to lag the interest rate changes,
both on the up and the down cycle, which means that if rates do
start sharply rising, it is not a guarantee that lenders are
going to follow that up in lock step with whatever short-term
index is going, but rather they have the discretion of
spreading that out and lagging that, and statistically, that
has been the case over the last couple of decades.
Senator Corker. Yes, sir?
Mr. Pollock. An interesting difference between commercial
credit markets, which you referenced, Mr. Chairman, and
residential markets is commercial markets invariably have loan
covenants, so with either private placement investors or banks
or bond indentures, as a borrower, you are committing to
maintaining certain levels of capitalization or earnings or
inventory coverage or what not, whereas we do not have such
things in residential loans.
I was in a discussion recently, and I think it is an idea
worth thinking about, where there might not be covenants added,
and these might develop if we really had a private market, to
residential mortgages, for example, prohibiting the taking on
of second lien borrowings without the agreement of the first
lienholder so that you get a more commercial-like contract and
you are not allowed as a borrower to run your leverage of the
household up to foolish levels. It is something worth thinking
about, anyway. But it is a clear, interesting distinction
between the two markets.
Senator Corker. And I might add, and I certainly look
forward to hearing from you, but I might add that especially in
an environment where basically the servicers of these first
mortgages are usually the ones that have the locks on the
second mortgage, so they are looking after their interest
naturally more so than the prime lender is.
Dr. Wachter.
Ms. Wachter. Yes, and this is an interesting idea, and
other countries have other ways of getting to the same
conclusion. For example, in Canada, you cannot refinance your
mortgage if it is over 80 percent without the mortgage
insurance agreement to that.
Senator Corker. So it sounds like, looking at the body
language, all three of you would support loan covenants as a
part of whatever we might propose. It is certainly on any kind
of Government support system, is that correct?
[Panel nodding heads.]
Senator Corker. Is there anything demographically about our
country that is different than others as it relates to how our
whole loan system has evolved and why it is so different than
most other countries?
Mr. Pollock. Well, one reason we could say that Canada is
an interesting comparison is that demographically we are both
nations of immigrants and frontiers and pioneers and
settlement, which gave us a land holding population. We still
have heavy immigration, which we keep assimilating and trying
to assimilate into home ownership, which is an interesting
issue to think of. We would think about it generationally as
cohorts of the family or of the generations of the family
establish themselves in American society and move to home
ownership that they could not afford in the beginning.
Ms. Wachter. There are countries with serious problems of
renters versus owners, where renters are have-nots in the sense
that they cannot become renters [sic]. Their families do not
have the wealth. Their families have not been owners. And with
development and price rises, it is possible that these sectors
will be out of home ownership entirely, leading to real
stresses.
In our country, despite the fact that we have had these
tremendous immigrants fueling our growth, we have also
incorporated immigrants into home ownership so that they have a
stake in our country. And as housing prices have risen, their
wealth has risen with it, so that instead of being kept out of
the potential of home ownership generation to generation, they
have been able to buy into America's growth. I think this is
extraordinarily important going forward.
Senator Corker. Any comments?
Mr. Lea. You know, I do not really know that there is a
major demographic argument for a lot of the characteristics of
our system. As Dr. Wachter said, we have historically had a
bias or penchant for home ownership for good reasons. But if
you look at the legislation and language of a lot of other
countries, they will also say that home ownership is really
good, but they do not necessarily think it is good for
everybody, and then the question becomes do you have the kind
of support systems for lower-income people, for rental or
people that are doing that in order to save and in order to
own.
So I think that our system is actually--its characteristics
are more defined by the very longstanding role that governments
had, going all the way back to the 1930s, creation of FHA and
Fannie Mae, prohibition of adjustable-rate mortgages until the
early 1980s. That explains a lot more about why our system
looks the way it does than any demographic feature.
Senator Corker. And all three of you, I think, would
support some type of legislation to deal with covered bonds but
do not see it as a panacea to our housing, is that correct? All
three of you think that----
Mr. Pollock. Yes.
Ms. Wachter. Yes.
Mr. Lea. Yes for me.
Ms. Wachter. Yes for me, but I do actually think it is, in
fact, going the other direction. Covered bonds are not only not
a panacea, but they can be a source of systemic risk, as we see
in Spain.
Senator Corker. So they can add risk to the system if you
do not properly balance----
Ms. Wachter. Absolutely.
Senator Corker. ----off what the FDIC's rights are
against----
Ms. Wachter. Exactly.
Senator Corker. Yes. In closing, we have been here almost
an hour and a half now, and are there any closing thoughts? I
know you all had opening comments. I have asked a few
questions. Are there any other comments or thoughts you would
like to share with us before we adjourn?
Mr. Pollock. If I could, I would just repeat, Mr. Chairman,
that looking at this in an international context where you see
a lot of different evolved systems around the world is really a
fruitful thing to do because we need to think anew about the
way American housing finance, which is a huge market, hugely
important economically and socially, but it needs to work quite
a bit differently, in my judgment, than it has in the last
generation, and, in fact, in the generation before that. So it
is definitely time for these bigger, more open-ended thinking
about what we might do.
Ms. Wachter. I think it is also useful to look at the
successes, but also to look at the failures, and the European
regulators are looking at their failures at the same time. So
cross-country examination and looking together at what works.
We are not a nation alone. Our crisis helped bring down other
markets. Other markets also affect us. I absolutely think it is
important to have an international perspective and I do thank
you for the opportunity to speak to it today.
Senator Corker. Thank you.
Mr. Lea. And I would just add that there is no perfect
system. We cannot say that one that is totally adjustable rate,
bank deposit funded, or one that is totally fixed rate,
security funded, is ideal. In act, both have their strengths
and weaknesses, and I think what we can draw from the
international experience is there is a diverse set of ways,
both instrument and institution, that you can provide
sufficient credit for housing and for home ownership, and I
think we should look at, again, having a diverse menu of
products, funding types with essentially the interplay of
investors and borrowers determining what that mix looks like.
Senator Corker. You know, we have just gone through,
obviously, a huge financial regulation bill and some tangible
decisions were made and then some, in many cases appropriately
so, regulators are making decisions. In the area of housing
finance, because of the involvement we have had, which has
been, let us face it, 90 percent of the market today, we are
going to have to make some tangible, hard decisions as it
relates to housing finance going ahead. As a matter of fact, I
think it is going to be in many ways a far more difficult issue
for us to come to terms with and solve because it affects so
many people. And again, our involvement in it today is it is
such a huge level--I am talking about our Government
involvement.
So I thank you for coming today. I know that there will be
people here, staffers and others that represent folks that will
want to ask additional questions, and so we will leave the
record open, I am sure, for a couple of days and we look
forward to calling on you.
I know in our own office, we are trying to develop a sort
of a thesis, if you will, about the direction that we think
this ought to go. I know the New York Fed informally has come
up with some ideas. I know others are doing the same. We thank
you very much for traveling as far as many of you did today,
for all of you being here, and look forward to your continued
input. Thank you very much.
Ms. Wachter. Thank you.
Mr. Pollock. Thank you.
Mr. Lea. Thank you.
Senator Corker. The hearing is adjourned.
[Whereupon, at 3:58 p.m., the hearing was adjourned.]
[Prepared statements supplied for the record follow:]
PREPARED STATEMENT OF MICHAEL J. LEA
Director, The Corky McMillin Center for Real Estate, San Diego State
University
September 29, 2010
Mr. Chairman, Ranking Member Corker, and Members of the
Subcommittee thank you for the opportunity to be here today. I am
Michael Lea, Director of The Corky McMillin Center for Real Estate and
Professor of Finance at San Diego State University. I have an extensive
background in housing finance including senior executive positions at
major mortgage lenders and as Chief Economist of Freddie Mac. I have
been actively involved in the study of international housing finance
systems for more than 20 years having done consulting and business
development work in 30 countries and serving as Director of Research
for the International Union of Housing Finance. I recently completed a
comparative study of developed country mortgage markets that will be
published by the Brookings Institution later this fall as well as a
comparative study of mortgage instrument design released by the
Research Institute for Housing America. I would request that both
studies be entered in the record as they provide data support for the
points I will make today. (See, Attachments 1 and 2 following this
statement.)
In addressing the Subcommittee today you have asked me to compare
the structure and performance of major developed housing finance
systems with a focus on Australia, Canada, Denmark, Germany, and the
United Kingdom. The three major issues you have asked me to emphasize
are home ownership and affordability, the role of the Government in
mortgage finance, and the dominant mortgage instrument, funding
mechanism, and underwriting standards. I will address each in turn.
Home Ownership and Affordability
The United State has a relatively high home ownership rate of 67
percent. This rate puts the U.S. in the middle of a group of 11
countries. Australia, Canada, Ireland, Spain, and the U.K. have higher
rates while Denmark, Germany, Japan, the Netherlands, and Switzerland
have lower rates. Countries in Northern and Western Europe have lower
rates of home ownership in part because of significant social rental
programs. Such programs are less significant in Southern Europe with
corresponding higher home ownership rates.
Although many countries extol the virtues of home ownership there
is far less intervention to support affordable owner-occupied mortgage
lending in other developed countries. No other developed country has
``housing goals'' or Community Reinvestment Act legislation. Only
Canada and the Netherlands have government-owned mortgage insurance
agencies and in neither case is the insurance targeted to affordable
housing.
Many European countries provide greater rental housing assistance
than the U.S. Subsidized social rental housing is a significant sector
of the market in Western and Northern Europe and the U.K. The housing
is owned by municipal governments or nonprofit groups. Subsidies take
the form of rent assistance and financing assistance (e.g., municipal
guarantees, State loans). Generally the assistance is available to all
households who qualify (income targeting) and in some countries
(Denmark, Netherlands) it is available to homeowners as well as
renters. Australia and Canada have more limited assistance programs.
They provide targeted rental assistance but do not support social
housing to a significant extent.
The recession has had limited impact on home ownership in other
countries but a more significant effect on house prices. High house
prices in some countries limited home ownership opportunity prior to
the crisis. No other country has experienced the magnitude of mortgage
defaults and foreclosures that force households out of home ownership.
However, underwriting criteria have tightened worldwide which will
ultimately have a negative influence on home ownership, particularly
for first time homebuyers and self-employed borrowers.
House prices declined in all countries except Australia in 2008 and
remained depressed in most countries in 2009. House prices increased
significantly in Australia and Canada in late 2009 and 2010 and have
risen in several other countries including the U.K. Only Ireland has
experienced an extent of decline comparable to the U.S.
Extent of Government Involvement in Mortgage Finance
The U.S. is internationally unusual in the extent of government
involvement to support owner-occupied mortgage finance. No other
developed country has a government-sponsored enterprise similar to
Fannie Mae and Freddie Mac. Only Canada and Japan have government
mortgage security guarantee programs equivalent to Ginnie Mae. Only
Canada and the Netherlands have government-owned mortgage insurance
companies. Australia sold its government mortgage insurer to the
private sector in 1997.
For countries with government mortgage market support the market
share of government-supported entities is far less than the current
U.S. situation in which over 90 percent of mortgage credit is coming
from Government-backed institutions. In Canada approximately 50 percent
of mortgages have government-backed mortgage insurance which is
required for all loans over 80 percent loan-to-value (LTV).
Approximately 25 percent of mortgages have been securitized with
guarantees from the Canada Housing and Mortgage Corporation. A similar
proportion of mortgages have been securitized in Japan with guarantees
from the Japan Housing Finance Agency. Governments do not support
mortgage securitization in other countries.
A minority of countries allow a tax deduction of homeowner mortgage
interest. Only the Netherlands and Switzerland have unlimited
deductibility. Denmark, Ireland and Spain limit the deduction and
interest is not tax deductible in the other countries including
Australia, Canada, Germany, and the U.K. Households in these countries
tend to pay down debt faster reducing mortgage risk. Tax-exempt bond
financing programs for owner-occupied housing are also unique to the
United States. Australia, Canada, and the U.K. have small first time
homebuyer tax credit programs.
Mortgage regulation has been tightened in many countries as a
result of the crisis. Canada and U.K. now require ARM qualification at
higher than initial rates. Canada lowered the maximum LTV and term on
bank originated mortgages. Both Australia and the U.K. have introduced
suitability standards for mortgage lenders. Both the European
Commission and individual country regulators are contemplating tighter
underwriting parameters.
Mortgage Instruments, Funding, and Underwriting
The U.S. is internationally unusual in the market share of a long-
term, fixed rate mortgage (FRM). Only two other countries have a
dominance of this instrument: Denmark and France. Like the U.S. FRM,
borrowers in Denmark can prepay their loan without penalty if mortgage
rates fall. In France borrowers who refinance must pay a penalty and
the typical term is shorter, 15 to 20 years. The Danish instrument adds
a unique and valuable feature to its fixed rate mortgages. The
Principle of Balance results in a one-to-one correspondence between a
mortgage loan and a bond that finances it. If interest rates rise the
borrower, through their mortgage lender, can repurchase the bond at a
discount and cancel the mortgage. In this way the borrower can reduce
debt and the likelihood of negative equity.
The dominant mortgage instruments in other countries correspond to
one of two models--either adjustable rate mortgages (ARMs) or short to
medium term fixed rate ``rollover'' mortgages. The dominant instrument
in Australia, Spain and the U.K. is an adjustable rate mortgage.
Reliance on this instrument has been credited with reducing the
incidence of default during the crisis. However it is clear that there
is significant credit risk in the system if and when rates rise.
The dominant instrument in Canada and many European countries is
the rollover mortgage. With this instrument the loan rate is fixed for
a period of 1 to 10 years (typically 1-5) with a longer amortization
period (25-35 years). Borrowers are subject to a prepayment penalty for
refinance during the time the rate is fixed. The rate is renegotiated
at the end of the fixed rate period, adjusting to the market rate.
Borrowers can manage interest rate risk by shortening or lengthening
the fixed rate period at adjustment depending on the level and trend in
rates.
The dominant mortgage instrument in individual countries reflects
historical patterns, funding sources and government involvement. The
U.S. is internationally unusual in its dependence on securitization for
funding. Over 60 percent of the stock of mortgages has been securitized
mostly through the government-backed entities. Today over 90 percent of
U.S. mortgage funding comes through securitization. The highest
proportion of loans securitized in other countries is approximately 25
percent in Canada, Spain, and the U.K. The dependence on securitization
in the U.S. is driven by two factors; the predominance of the FRM and
the involvement of the government agencies. GSE and Ginnie Mae
securities primarily fund FRMs. Government backing lowers the relative
price of that instrument leading to a larger market share. Lenders
depend on securitization to fund such loans because of the high degree
of interest rate risk they entail (as evidenced by the savings and loan
failures in the 1980s).
Mortgage lending in adjustable-rate countries is dominated by
commercial banks. They prefer this instrument because it minimizes
interest rate risk for the bank--by passing it to the borrower. In
Australia and the U.K. the rate is set for all borrowers at the
discretion of the bank. Lenders typically lag the market in rate
adjustment. In times of rising rates banks cushion the interest rate
shock with gradual rate increases.
Banks finance mortgage lending in rollover countries primarily
through a combination of deposits and covered bonds. Covered bonds
finance approximately 20 percent of mortgage lending in the European
area. Outside of Denmark the bonds are bullet instruments of varying
maturities. Mortgages have prepayment penalties that facilitate match
funding by covered bonds or a combination of deposits and interest rate
swaps.
Mortgage Performance and Underwriting
The default and foreclosure experience of the U.S. market has been
far worse than in other countries. Serious default rates remain less
than 3 percent in all other countries and less than 1 percent in
Australia and Canada. Of the countries in this survey only Ireland,
Spain, and the U.K. have seen a significant increase in mortgage
default during the crisis.
There are several factors responsible for this result. First
subprime lending was rare or nonexistent outside of the U.S. The only
country with a significant subprime share was the U.K. (a peak of 8
percent of mortgages in 2006). Subprime accounted for 5 percent of
mortgages in Canada, less than 2 percent in Australia and negligible
proportions elsewhere.
Second while some countries including Australia, Canada and the
U.K. relaxed documentation requirements there was far less ``risk
layering'' or offering limited documentation loans to subprime
borrowers with little or no down payment. There was little ``no doc''
lending.
Third, there has been less prevalence of negative equity in other
countries. Although many countries allowed high LTV loans, the
proportion of loans with little or no down payment was less than the
U.S. and the decline in house prices in most countries was also less.
Fourth, loans in other developed countries are with recourse and
lenders routinely do go after borrowers for deficiency judgments.
Research in Europe and the U.S. has found that recourse reduces the
incidence of default. With a much smaller proportion of loans that are
securitized lenders are more apt to work with borrowers to restructure
loans rather than go through a lengthy and costly foreclosure process.
Lenders have moved to tighten underwriting guidelines since the
onset of the crisis. Down payment requirements have increased, loan-to-
income criteria have been tightened, there are fewer interest only
loans available and in some countries the maximum mortgage term has
been reduced. In most cases this has been at the volition of lenders
and not imposed by regulators. To date there have been few government
mandated minimum underwriting standards or product restrictions such as
those in the Dodd-Frank legislation.
Conclusions
There is no ideal housing finance system. Individual country
arrangements reflect history, market structure and government policy.
However, almost all developed country housing finance systems performed
better during the crisis than that of the U.S. What can the U.S. learn
from other countries?
First in no other country is there as much government involvement
in the mortgage market. The combined effect of the various forms of
government intervention undoubtedly contributed to the housing boom and
bust in the U.S. Other countries have achieved comparable or higher
rates of home ownership and well-developed, stable mortgage markets
with much less government support.
Second, features of the Danish system offer the prospect of real
improvement in the U.S. housing finance system. It retains the core
fixed rate mortgage product but makes it more consumer and investor
friendly by adding the option to repay the loan through the bond market
if rates rise. This feature would have reduced some of the negative
equity build up in the U.S. system during the crisis and the
significant extension risk faced by mortgage security investors today.
The Danish model could be adopted by the GSEs to facilitate its
introduction with a transition to a nongovernment guaranteed bond
market such as the one that exists in Denmark today.
Third, European style covered bonds can provide an alternative to
funding through GSE securitization. The market is deep and liquid in
Europe and has performed much better than the structured finance
markets. The instruments are simple, bullet bond structures backed by a
pool of conservatively underwritten mortgage assets and the capital of
the issuer without government guarantees. Incentives are aligned as
credit risk remains on the balance sheet of the issuer.
However, the fixed rate mortgages funded by covered bonds have
prepayment penalties allowing issuers to meet strict asset-liability
matching requirements. The recently passed Dodd-Frank financial reform
legislation reinforces long-standing restrictions on the use of
prepayment penalties that will hamper the development of a European
style covered bond market
Fourth it should be recognized that the high proportion of FRMs
funded through securitization in the U.S. is both the outcome of
Government involvement and a justification for its continuation. The
risks inherent in the FRM realistically require it to be funded in the
capital markets. Investors require government guarantees against loan
or issuer default to invest in mortgage-backed securities with volatile
cash flows. Thus the argument is made that we need to continue
Government support through the GSEs and/or Ginnie Mae to keep the
mortgage market functioning. Their guarantees lower the relative cost
of the FRM sustaining its dominance. The result is that the Government
backs the majority of all mortgages in the U.S.
If Government guarantees for mortgage-backed securities were
reduced or withdrawn over time the U.S. market would most likely
achieve a more balanced mix of products and funding sources. Adjustable
rate mortgages, medium term fixed rate mortgages and long term fixed
rate mortgages all have a place in a robust mortgage market. Likewise,
funding through deposits, bank bonds, covered bonds, and securitization
allows lenders to tap a variety of funding sources and manage the risks
of the various instrument designs.
The experience of other countries shows that high rates of home
ownership and stable well-developed mortgage markets can be achieved
without the degree of government intervention that exists in the U.S.
today. In that respect the U.S. clearly can learn much for
international housing finance systems.
Thank you for the opportunity to appear before this Subcommittee.
Attachment 1
Attachment 2
PREPARED STATEMENT OF SUSAN M. WACHTER
Richard B. Worley Professor of Financial Management, Professor of Real
Estate, Finance, and City and Regional Planning, The Wharton School,
University of Pennsylvania
September 29, 2010
Chairman Bayh, Ranking Member Corker, and other distinguished
Members of the Committee, thank you for the invitation to testify at
today's hearing on the ``Comparison of International Housing Finance
Systems.'' It is my honor to be here today to discuss the strengths and
weaknesses of various models, how they differ from the United States
system and any lessons or themes that may be learned from their
experiences prior to, and during, the global economic crisis.
The United States belongs to a group of countries that suffered
particularly severe recessions driven by sharp housing price crashes.
Other countries in this category include the United Kingdom, Spain, and
Ireland. On the other end of the spectrum are countries where home
prices merely leveled from 2007 to the present, resulting in no or mild
recessions. This category encompasses Canada, Australia, and Germany.
(Denmark lies somewhere in the middle, with a late bubble and current
downturn.) By comparing these two groups, we can investigate what
causes and what prevents housing bubbles and financial crises. In a
forthcoming paper with colleagues, we conduct just such an
investigation and find that two institutional differences separate
these groups: the role of mortgage insurance (MI) and the strictness of
regulations countering the market's tendency toward procyclical
behavior.
No country better exemplifies this procyclicality in housing and
mortgage markets than the U.S. With economic growth and low interest
rates coming out of the recession of 2000-2001, mortgage lenders and
securitizers increased lending and competed for market share among
borrowers. When the available market was satiated, they expanded the
market by lowering their standards to include less creditworthy
borrowers. An expanding economy thus drove lax lending standards, the
increase in nonstandard mortgages, and the proliferation of private-
label securitization (PLS). It also encouraged regulators and bankers
to increase leverage (i.e., lower capital requirements) to maximize
profits. Eventually, borrowers found themselves with too much debt to
repay, and the downward spiral of foreclosures, defaults, home price
declines, and decreased aggregate demand ensued. Unfortunately, banks
had too little capital--especially in liquid form--to cushion the blow,
forcing them to curtail lending and even file for bankruptcy. The free
market naturally motivates firms to lower lending standards and capital
buffers in good times, thus adding momentum to the upswing, and to
increase lending standards and capital buffers in bad times, thus
reducing economic activity when the system needs it the most.
While lending standards deteriorated, the extent to which this was
occurring was unknown due to information opacity, the underlying
mortgages were complex and difficulty to track, the extent of fake
equity, in which the rise in house prices was due to unsustainable
product growth was unknown.
In the U.S., mortgage insurance and regulation declined as the
housing bubble grew, thus magnifying this pro-cyclical behavior.
Regulators who brought attention to declining lending standards, an
increase in aggressive and predatory lending, and a rise in loan-to-
value (LTV) ratios were ignored or overruled. Mortgage insurers could
have served as a ``third party control,'' as they must pay the
remaining value of the mortgage if the homeowner defaults, but
originators came to rely less and less on MI because they could pass on
the default risk to investors via securitization. To deal with low down
payments that would have triggered the need for mortgage insurance,
piggy back loans were originated and these too were securitized. When
Fannie Mae and Freddie Mac securitized mortgages, they bore the default
risk, making them the ``third party control.'' However, when Wall
Street securitized mortgages, the default risk transferred to the
buyers of the mortgage-backed securities (MBS). Because the mortgages
and the MBS were becoming more complex and heterogeneous, investors
could not assess the default risk, as evidenced by the fact that they
were accepting lower interest rates (even in comparison to Treasuries)
for riskier products.
Contrast this experience to that of Canada, where regulators
mandate that all high-LTV mortgages must be covered by MI. This
practice has not inhibited Canada from achieving levels of home
ownership on par with those of the U.S. in 2004, at their peak. Canada
and Australia in this time period as well relied on mortgage insurers
as a ``third party regulator'' with the result that mortgage lending
standards did not deteriorate and housing prices did not collapse.
Mortgages in Australia and Canada were and are typically short term
variable rate, or in the case of Canada, rollover, and were originated
and to a large extent held in portfolio by banks. Both countries
avoided recessions, home ownership has been maintained at high levels,
and their banking systems have been able to continue lending as the
crisis has caused financial systems in other countries to stop
functioning. Australia has a significant ARM share, but regulators
prohibited lenders from issuing ARMs to borrowers who did not qualify
for the highest projected rate over the life of the loan. Thus,
Australia was spared the fate of the U.K., Denmark, and Spain.
A system reliant on MI can only work, however, if the insurers
maintain enough capital to cover defaults during economic downturns.
The U.S. is an example of what can happen when this principle is
ignored. Credit default swaps (CDS) acted like insurance on MBS, but
CDS issuers like AIG did not have enough capital to cover the defaults
and were not required to reserve for the risk they were holding. Thus,
MI is only one half of the equation, with strict countercyclical
capital regulation being the other half. Canada is an excellent example
of maintaining both ends of the equation. Their adjustable rates were
regulated to prevent predatory behavior; for example, originators were
not allowed to use low ``teaser'' rates.
The structure of the dominant mortgage product is also critical to
preventing procyclicality. Most countries rely on adjustable-rate
mortgages (ARMs). The U.S., Denmark, and Germany are the three notable
exceptions, favoring fixed-rate mortgages (FRMs). ARMs place the
interest rate risk on the borrower, who is not as well-suited to bear
it as lenders and investors. When interest rates rise, borrowers may
have difficulty making payments and may be forced to default. ARMs also
subject the borrower to greater market risk because their interest
rates may rise when defaults increase elsewhere in the economy. ARMs
are less conducive to systemic stability, as exhibited during the
recent economic crisis. During the housing bubble, securitizers'
appetite for market share drove them to demand riskier mortgages from
less creditworthy borrowers. Originators responded by favoring ARMs
over FRMs, and it was these nonstandard mortgages that eventually
exploded. The U.K. and Spain also relied on ARMs with similar
consequences. All countries with ARMs saw their lending dry up during
the credit crunch with borrowers unable to refinance at the high new
rates. With ARMs that need to be repaid or refinanced the illiquidity
of the system may be transformed as in these countries into a solvency
or foreclosure crisis.
Building a system around the FRM requires a secondary market. Banks
do not want to bear the interest rate risk of ``borrowing short'' from
depositors and ``lending long'' to homeowners. When interest rates
rise, they will have to pay more to depositors but will be receiving
the same low payments from homeowners that were established when the
contract was signed. This mismatch was directly responsible for the
U.S. savings and loan crisis two decades ago and similar crises
elsewhere. While in practice they can hedge this risk with derivatives,
in practice no country has a banking system reliant on FRMs without
secondary market institutions that bear some of that risk and/or
increase their profitability. In the U.S., Fannie Mae and Freddie Mac
serve that role by purchasing FRMs and securitizing them. Unlike PLS of
ARMs, this securitization yields a product that would not otherwise
exist. In Germany, banks issue ``covered bonds'' (instead of MBS) that
are secured by standardized mortgage loans through Pfandbrief
institutions. While the investor who purchases a covered bond receives
the cash flows from the homeowner, the issuer who sold the covered bond
retains the default risk. If the homeowner defaults, the issuer owes
the remaining balance to the investor. Unfortunately, the stringent
loan to value requirements of the system in Germany has resulted in one
of the lowest home ownership rates in the industrialized world, relying
on renting for over half its population.
But without the proper regulations, even covered bonds can get a
country into trouble. German regulators ensure that investors get
periodic updates on the state of the collateral securing their covered
bond, and they do not allow covered bonds to be secured by loans with
an LTV ratio above 60 percent. Unlike in the U.S., these regulations
were not eroded during the housing bubble. Denmark also relies on
covered bonds and had similarly stringent regulations until recently.
When Danish legislation moved the system toward interest-only
mortgages, the market joined the housing mania and developed a late
bubble that subsequently deflated. Similarly, Spain used covered bonds
extensively, yet they slid toward ARMs in recent years. The Spanish
banks, cajas, securitized ARMs through cedulas in an effort to generate
fees and gain market share, generating a bubble and crisis that is
severe, with Spain suffering 20 percent unemployment. In the face of
rising prices, it is very tempting to lower lending standards,
contributing to procyclicality.
All industrialized nations have significant government involvement.
When the housing market is in crisis, it endangers the entire system.
The British rescue of Northern Rock preceded the American bailouts and
the Spanish government has intervened to protect the cajas and their
covered bonds. To prevent a foreclosure crisis from driving an economy
into a severe recession or depression, governments will intervene; thus
it is necessary to regulate the housing finance market before it
reaches the crisis stage. The taxpayer owns the tail risk. Rather than
raise lending standards after the fact, we can prevent the problems of
moral hazard, shrinking equity, and bailouts by maintaining standards
and transparency.
The clearest difference between the U.S., the U.K., and Spain, on
one side, and Australia, Canada, and Germany, on the other, is the
stability of regulation. The first group allowed lending standards and
capital requirements to decline, stoking the pro-cyclical behavior that
created a housing bubble and economic crisis, while the latter group
maintained rules in the face of market pressure.
Bibliography
``Housing Finance in Developed Countries--In a Time of Turmoil'',
coauthored by Richard Green, Adam Levitan, and Susan Wachter,
working paper, 2010.
``The American Mortgage in Historical and International Context'',
coauthor Richard K. Green, Journal of Economic Perspectives, Vol.
19, No. 4, Fall 2005, 93-114. http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=908976
``The Housing Finance Revolution'', coauthor Richard K. Green, Housing,
Housing Finance, and Monetary Policy: Symposium Proceedings,
Federal Reserve Bank of Kansas City, January 2008. Reprinted in The
Blackwell Companion to the Economics of Housing: The Housing Wealth
of Nations, eds. Susan Smith and Beverley Searle, London: John
Wiley & Sons, forthcoming 2010.http://www.kansascityfed.org/
Publicat/Sympos/2007/PDF/Green_Wachter_0415.pdf
______
PREPARED STATEMENT OF ALEX J. POLLOCK
Resident Fellow, American Enterprise Institute
September 29, 2010
Mr. Chairman, Ranking Member Corker, and Members of the
Subcommittee, thank you for the opportunity to be here today. I am Alex
Pollock, a resident fellow at the American Enterprise Institute, and
these are my personal views. Before joining AEI, I was the President
and CEO of the Federal Home Loan Bank of Chicago from 1991 to 2004.
From 1999 to 2001, I also served as President of the International
Union for Housing Finance, a trade association devoted to the
international exchange of housing finance ideas and practices, and
continue to be a member of its Executive Committee.
A Middle of the Pack Home Ownership Rate, GSEs Notwithstanding
As we begin the last quarter of 2010, our housing finance system
(as well as those of some other countries) is still struggling in the
wake of the great housing bubble of 2000-06 and its collapse into the
panic and serial crises of 2007-09.
Housing finance cannot be considered apart from its effects on
house prices. When you push a lot of credit at an asset class, its
price tends to rise. American housing finance practices and subsidies
helped inflate house prices during the bubble. Then U.S. average house
prices fell by more than 30 percent from peak to trough--something, we
must remember, which was previously considered impossible. This brought
them back to their long-term trend line and to the levels of 2003, with
all of the losses and turmoil with which we are so familiar. A
memorable decade! One of its lessons is to try to remember that things
considered impossible can nonetheless happen.
As we develop other lessons for the next decade, there is no doubt
that it is educational and useful to examine American housing finance
in international perspective.
Comparing our housing finance system to other countries, we
discover that one thing remarkable and indeed unique in the world about
American housing finance was the dominant and disproportionate role
played by Government-sponsored enterprises, namely Fannie Mae and
Freddie Mac, wielding their ``implied'' Government guaranty. Based on
this ``implied'' guaranty, massive amounts of their debt securities
were sold around the world, so that foreign institutions could help
inflate U.S. house prices without worrying about the risk and later be
bailed out as creditors by American taxpayers. Of course the
``implied'' guaranty always was a real U.S. Government guaranty, as
events have amply demonstrated, but it did not have to be accounted for
as one.
In the days of Fannie and Freddie's pride, their representatives
and political supporters used frequently to say, ``American housing
finance is the envy of the world!'' It really wasn't, at least based on
my discussions with housing finance colleagues from other countries.
But many Americans--including members of Congress--thought it was, just
as they mistakenly thought and said that the U.S. had the highest home
ownership rate in the world. We didn't and don't.
This is apparent from the table of Comparative Home Ownership Rates
on page 3. The U.S. ranks 17th of 26 economically advanced countries,
or about two-thirds of the way down the list.
I think we can agree that we would like our society to have a
property-owning democratic citizenry, which includes widespread home
ownership. But the international perspective makes it clear that many
countries achieve home ownership levels as high or higher than ours
with no GSEs. It turns out that these levels can be achieved without
tax deductions for the interest paid on home mortgages, without our
very unusual practice of making mortgages into nonrecourse debt,
without Government mandates to make ``creative'' (that is, riskier)
loans, without 30-year fixed-rate loans, and with prepayment fees on
mortgages. Of course, as bubbles and busts in other countries show, you
can also get in trouble with different systems.
At a minimum, we should never assume that the particular historical
development so far of the U.S. housing finance system is definitive.
Canada
The better credit performance of Canadian housing finance over the
last several years has become well known. The proportion of Canadian
mortgage loans more than 90 days delinquent in the first quarter, 2010
was less than \1/2\ percent. This is about one-tenth the ratio of U.S.
mortgages over 90 days delinquent at that time, which was 4.9 percent.
If we add to the U.S. number mortgage loans in foreclosure to look at
serious delinquencies, it jumps to 9.5 percent. Quite a contrast, as
many people have remarked.
Canada makes a pertinent comparison for the U.S. It is in
population and economic size much smaller, of course--about one-tenth
in both cases--but is in many ways very similar.
Both countries are rich, advanced, democratic, and stable, have
sophisticated financial systems and pioneer histories, and stretch from
Atlantic to Pacific. But Canada has no housing GSEs; mortgage loan
interest is not tax deductible; it does not have 30-year fixed rate
mortgages; it does have prepayment fees.
Mortgage lending is more conservative and creditor-friendly.
Canadian mortgage lenders have full recourse to the borrower's other
assets and income, in addition to the security interest in the house.
This means there is less incentive for underwater borrowers to ``walk
away'' from their house and mortgage. No tax deduction for interest
probably increases the incentive to pay down debt. Most Canadian
mortgage payments are made through automatic debit of the borrower's
checking account and can be matched to paycheck frequency--a technical
but important behavioral point. Canadian fixed rate mortgages typically
are fixed for only up to 5 years. Subprime mortgages were a much
smaller part of the market.
This relative conservatism has meant that Canadian banks, the
principal mortgage lenders, while experiencing some pressure, have come
through the international financial crisis in much better shape than
their U.S. counterparts, with (as observed above) mortgage
delinquencies so far well behaved.
There does not appear to have been a home ownership price to pay
for this relative credit conservatism. Canada's home ownership rate is
68 percent vs. 67 percent for the United States. Two very different
housing finance systems, one, as it turned out, much riskier than the
other, produced virtually the same home ownership rate.
It is important to recognize that Canada does have an important
government body to promote housing finance, which has a substantial
role: the Canada Mortgage and Housing Corporation (CMHC). Among its
principal activities is insuring (guaranteeing) mortgage loans, another
is securitizing some of the insured loans. So you could think of it in
one sense as a combination of FHA and Ginnie Mae. (Its mortgage
insurance program was originally modeled on the FHA in 1954.)
CMHC's mortgage insurance is a major factor in the market, covering
about C$470 billion out of total mortgage debt of about C$ 950 billion,
or roughly half of Canadian mortgages. This is the same proportion as
the combined Fannie and Freddie in the U.S. (over $5 trillion out of
about $10 trillion).
Whether or not you like the idea of such a scale of government
financing, you have to say that, in contrast to the American GSEs, at
least CMHC's status is completely clear and honest. It is a 100 percent
government-owned and controlled corporation. Its government guaranty is
explicit, so it operates with the formal full faith and credit of the
government of Canada. It also provides housing subsidies which are on
budget and must be appropriated by Parliament.
Canada in this respect looks superior to the U.S. in candor, as
well as credit performance.
However, CMHC does obviously represent a large government
intervention in the housing finance market. Recalling our previous
point about the interaction of housing finance and house prices, one
Canadian criticism is that this intervention has caused excessive
inflation in Canadian house prices. Indeed, Canadian house prices
measured relative to a base of the year 2000, have now risen higher
than U.S. relative house prices at the top of the bubble, as shown in
the following graph.
A general rule is that as long as house prices are rising, mortgage
loan performance will be good. Some Canadian commentators worry about
whether their house prices are in a bubble. The Fraser Institute, a
Canadian free-market think tank, has called the Canadian mortgage
system ``a high taxpayer-vulnerability model.''
In response to these worries, Canadian regulators have taken
important countercyclical actions to lower the maximum loan-to-value
(LTV) ratios on some of the riskier classes of mortgage loans. In other
words, they now require larger down payments and allow less leverage of
the properties. Such countercyclical movement in LTV limits, in my
opinion, is an excellent idea and necessary to moderate the inevitable
cycles in real estate credit. We should stay tuned to the highly
interesting Canadian housing finance story.
Matching Mortgage Assets and Mortgage Funding
The traditional and still typical Canadian mortgage has a long-term
amortization schedule (up to 35 years for CMHC-insured mortgages), but
with an interest rate fixed for 5 years, after which the interest rate
is reset for another 5 years, and so on. Shorter fixed periods are also
common, but the debt service to income ratios are to be approved based
on the prevailing 5-year rate.
About two-thirds of mortgages remain on the balance sheet of the
lenders, which are dominated by five nationwide banks. The 5-year fixed
rate mortgage loans are often funded by the issuance of 5-year fixed
rate certificates of deposit, which gives a very good natural matching
(that is, no derivatives required) of the banks' assets and
liabilities. Obviously, such matching is also available for shorter
fixed rate periods.
This is a straightforward answer to a fundamental problem of every
housing finance system: how to match the nature of the mortgage asset
with an appropriate funding source, so that you are not lending long
and borrowing short. Different approaches distribute the risks among
the parties involved, including lenders, investors, guarantors,
borrowers and the government, in various ways. The classic example of
not achieving the needed match is the infamous collapse of the American
savings and loan industry in the 1980s.
There are clearly some basic variations:
Variable rate mortgages funded with short-term deposits;
Medium-term fixed rate mortgages funded with medium-term
fixed rate deposits or bonds;
Long-term fixed rate mortgages funded with long-term fixed
rate bonds or mortgage-backed securities.
In general, variable rate mortgages put the risk of rising interest
rates in the first place on the borrowers. To have long-term fixed rate
mortgages requires funding by some form of access to the long-term bond
market. Every housing finance system must address this fundamental
asset-liability question; the answer results in a particular
distribution of risks.
Denmark
The most perfect solution in theory, which also functions very well
practically in its national setting in an admittedly small country, is
that of the housing finance system of Denmark. It has been admired by
many observers. Explicitly governed by what it calls the ``matching
principle,'' the interest rate and prepayment characteristics of the
mortgage loans being funded, which include long-term fixed rate loans,
are passed entirely on to the investor in Danish mortgage bonds.
At the same time, there is a total ``skin in the game'' requirement
for retention of credit risk by the mortgage lenders. The mortgage
banks retain 100 percent of the credit risk of the loans, in exchange
for an annual fee, thus insuring alignment of incentives for credit
performance. Deficiency judgments, if foreclosure on a house does not
cover the mortgage debt, are actively pursued.
The fundamentals of the Danish mortgage system go back over 200
years. There are no GSEs or government housing banks. This is a private
housing finance system built on what appear to be quite robust
principles. It generates a home ownership rate of 54 percent, below
that of Canada or the U.S.
Some years ago, when the proud hearts of Fannie and Freddie had not
yet had their fall, I participated in an exchange with the Association
of Danish Mortgage Banks. They explained their mortgage bond- and skin
in the game-based system to me, then I explained the American GSE-
centric mortgage system to them.
When I was done, the CEO of one of the leading Danish mortgage
banks said this: ``In Denmark we always say that we are the socialists
and America is the land of free enterprise. Now I see that when it
comes to mortgage finance, it is the opposite!''
England
England has a large economy, is financially very sophisticated, and
has an entirely different housing finance structure. It also has no
GSEs. The traditional and still typical English mortgage is a variable-
rate loan financed by deposits in banks or mutual building societies.
The interest rate on these loans can be changed up or down at the will
of the lender, so everybody's rate changes at the same time. This is a
natural asset-liability matching for the depository institutions, but
is risky for the borrowers.
England had a housing boom and bust in the 21st century cycle, as
we did. Indeed, the first casualty of the financial panic was an
English mortgage lender, Northern Rock, which was a well-known
securitizer of mortgages. Northern Rock failed in 2007, long before
Bear Stearns did, when the wholesale investing market refused to
continue investing. This was followed by first a run on its retail
deposits, then by the nationalization of the bank.
England also had a unified financial regulator, the Financial
Services Authority, whose jurisdiction included mortgage lenders as
well as all other financial intermediaries. This unified regulatory
structure did not avoid the crisis.
Still, England has a home ownership rate of 68 percent, just ahead
of the U.S.
Germany
Some German banks got into serious trouble in the housing bubble,
but by investing in U.S. mortgage securities and other foreign
mortgages, not in their domestic mortgage lending market, which is
quite conservative. It generates a home ownership rate of 46 percent,
which would not be politically acceptable in an American setting.
Nevertheless, there are two German housing finance ideas worthy of
study. One is its mortgage covered bond (Pfandbrief). With a statutory
basis more than 100 years old (and it is claimed, a history going back
to Frederick the Great of Prussia), the covered bond has provided a
relatively stable source of bond-based mortgage financing.
Covered bonds allow a fixed rate funding for fixed rate mortgage
loans, and keep the credit incentives of the lender intact, since the
lender remains responsible for 100 percent of the credit risk and the
loans stay on its balance sheet. But they provide access to the bond
market, in addition to deposit-based funding, and are indeed a major
component of the German bond market. The mortgage loans serve as
collateral for the bonds, which are also senior obligations of the
issuing mortgage lender.
Many people have proposed, and I agree, that the U.S. should
introduce covered bonds as a mortgage funding alternative--one which
does not involve a government guaranty. The German experience suggests
these lessons:
There needs to be a statutory basis for these bonds, not
merely a regulatory one, to insure the bond holders' rights to
the collateral are truly protected.
The mortgage loans serving as collateral for them (the
``cover pool'') should be subject to conservative credit
standards, to reduce the volatility and uncertainty of their
credit behavior.
A second German housing finance idea for consideration is
emphasizing (we should say, rediscovering the needed emphasis) on
savings as part of sound housing finance. Thus, the German building and
savings banks (Bausparkassen) continue to practice the traditional
``savings contract,'' by which the borrower commits to a regular
savings program as part of qualifying for a mortgage loan.
I am not recommending their specific program, but the general
principle. We have completely lost the emphasis on savings as part of
housing finance. We need to rediscover it.
Switzerland
Switzerland may just be mentioned as a case of the variety
exhibited by housing finance in international perspective. It is a
wealthy country with a very large and sophisticated financial sector.
It has mortgage debt outstanding of about 100 percent of GDP, somewhat
higher than in the U.S.
Yet Switzerland has a home ownership ratio of only 35 percent, the
lowest on our list.
It is an unusual housing finance example. So is the American GSE-
centric system, which has collapsed at heavy taxpayer expense, as did
the American savings and loan system which preceded it.
Conclusion
The variety of international experience suggests that there is
every reason to think broadly and openly about the possibilities for
developing a better, post-GSE U.S. housing finance system for the
future.
Thank you again for the opportunity to share these views.