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Guest Blog Post: “No more of the same failed finance systems”

by Tom White and Charlie Wilkins

NHC invites guest blog posters to write on important housing topics.  The views expressed by guest posters do not necessarily reflect those of NHC or its members.

Today we face a global housing finance crisis as a result of failures in single family finance. But make no mistake, the same factors that caused the single family finance crisis – a federal guaranty for mortgage loans, the failure to assess risk accurately, and inappropriate capital requirements – have been at work in the multifamily industry as well.

Yet industry participants say that there is no problem in multifamily and seem to be calling for ‘more of the same, except with less discipline’. See, for example, position papers from the National Multi Housing Council, the National Housing Conference and the Center for American Progress.

We have spent our careers working in apartment finance and apartment program administration, and we disagree. Instead, ‘more of the same is the wrong idea, and we need more discipline, not less’.

For a full discussion, see our longer paper available here or by contacting us.

We take issue with the conventional wisdom in three major ways:

  • Industry participants imply that because we have a government-dominated multifamily lending system today, we need one in the future as well. We disagree; the present government-dominated system should be dismantled over time and replaced with a fully private system.
  • Industry participants imply that because the GSE multifamily programs have remained profitable, they are safe. We disagree; although the GSE multifamily lending programs have been generally prudent and safe, the GSE capital requirements were and are too low to protect against a repeat of 1989-1991 multifamily market conditions.
  • Industry participants imply that because the GSE multifamily experience has been good, multifamily lending is safe. We agree that prime multifamily lending is safe, but most of the lending that industry participants want is below-prime lending that is risky and that should only be made by private lenders with their own capital at risk.

A Government-Dominated Multifamily Lending System is Bad Policy and Bad Economics

Other countries have viable, stable mortgage credit markets without a government guaranty (see our longer paper). So there is no reason to think that a guaranty is necessary in the United States. Clearly, however, a federal guaranty involves significant risk to taxpayers. We believe that a federal guaranty saddles the government with a lot of risk, for little or no actual gain.

Government has proven time and time again – and not just in housing – that government is not an efficient market maker. Government domination of a lending market always distorts the behavior of borrowers and lenders and politicians. Federal backing becomes incompatible with the ‘skin in the game’ that keeps a creative discipline in lending products.

GSE Multifamily Programs Have Been Successful But Not Over a Full Market Cycle

It is true that GSEs have had a strong performance in multifamily, but that performance does not cover a full market cycle. Although recent single family market conditions represent a true bottom of cycle, in order to find a multifamily bottom of cycle, we have to look back to 1989-1991. That is, to a time that predates current GSE multifamily efforts. Similar conditions prevailed in 1974-1976. In a repeat of those market conditions, we would have seen GSE multifamily failure, even with the generally conservative loans that the GSEs made over the past 15-20 years. Said bluntly, the 0.45% capital requirement for the GSEs was and is too low, even for prime multifamily loans.

We believe that the current GSE programs were created in a sort of reverse bubble, in a reaction to the disastrous losses that multifamily lenders suffered in the 1989-1991 market bottom. In the aftermath, the GSEs created conservative and prudent programs, and government regulators did not meddle. We believe that if a federal guaranty for multifamily is continued, government will meddle, risk will increase, and taxpayers will ultimately suffer.

Prime Multifamily Loans Are Safe, Below-Prime Multifamily Loans are Risky

We happen to agree that over the past 15-20 years the GSEs demonstrated what prime multifamily mortgage loans were, how to make prime multifamily mortgage loans, and that prime multifamily mortgage loans are safe investments. We also believe that prime (GSE-style) multifamily loans are on the order of five times safer than below-prime (conduit-style) multifamily loans.

Below-prime multifamily loans include construction loans, loans to properties in lease-up, “story loans” based on the hope of higher rents, loans in markets with declining population, loans in small markets, loans on small properties, loans exceeding 75%-80% of value, and loans to properties with complex subsidy structures. Curiously, however, industry participants (including the Center for American Progress and the National Housing Conference) want a federal guaranty to be extended to exactly these kinds of loans. That, we believe, would be a formula for disaster.

Say that the present 8.0% bank capital requirement is “right” for below-prime multifamily loans. If we are correct that prime multifamily loans are on the order of five times safer than below-prime loans, the “right” capital requirement for prime multifamily loans might be in the range of 8.0% ÷ 5 = 1.6%. That is, higher than the 0.45% GSE capital requirement but not nearly as high as the current bank capital requirement.

A Careful Transition is Needed

We acknowledge the fear of throwing away the crutch (the present federal guaranty for multifamily debt). We also acknowledge that a transition to a fully private multifamily lending market cannot occur overnight. Rather, we believe a transition is needed over a reasonable period such as five years.

In Closing

It is essential to return to a fully private multifamily mortgage system, without a federal guaranty. That system should make clear distinctions between prime and below-prime loans, with prime loans being rewarded with appropriately lower capital requirements.

Because multifamily and affordability are such closely related topics, in our longer paper we also argue for taking a careful look at the existing stock of federally subsidized apartments, to reach a better understanding of how to structure properties for long-term success.

We look forward to the debate.

Tom White

After leadership positions with the Michigan State Housing Development Agency and the National Council of State Housing Agencies, Tom White was responsible for Fannie Mae’s multifamily lending activities from the early 1990s through the early 2000s.

Charlie Wilkins

After being responsible for asset management of the National Housing Partnership’s 60,000 unit portfolio of affordable apartments, Charlie became a consultant in 1997 and now works primarily with regulatory agencies regarding affordable housing policy, finance, asset management and property management.

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