Policy Points: Multifamily Finance: The Neglected Issue in the Fannie-Freddie Debate

Published by Peter Lawrence on Tuesday, February 1, 2011
Journal thumb February 2011

By the time you read this column, the Obama Administration will have (or at least should have, according to congressional mandate) released its plan to reform the U.S. mortgage finance system, with much of the focus, attention and controversy on how the plan proposes to restructure the two titans of mortgage finance: Fannie Mae and Freddie Mae, also known as housing government sponsored enterprises (GSEs).

The GSE plan will kick off a big congressional debate on the appropriate role of the federal government in housing and mortgage finance. This debate will likely be centered on whether the government should be involved in housing finance at all; the importance of a 30-year, fixed-rate, fully amortized single-family mortgage to the housing market; whether residential mortgage-backed securities (MBS) should be explicitly guaranteed by the federal government; and the appropriate pricing of such guarantees, among other issues. There will be a vigorous argument about the limit of the single-family mortgage loans that Fannie and Freddie can purchase; in high housing cost areas, the current limit is as much as $729,725.

This congressional debate will undoubtedly have partisan overtones; newly empowered House Republicans will argue that we should wind down as much government involvement in the mortgage finance system as possible while Democrats—still in the majority in the Senate—will likely argue for a continued and sustained government role. There will even be a debate on whether Fannie and Freddie should continue to exist. Former House Financial Services Committee Chairman and now Ranking Member Barney Frank, D-Mass., who many believe is Fannie’s and Freddie’s greatest congressional champion, famously said last year that he thought Fannie and Freddie should be “abolished.”

This is an important debate that needs to happen. However, what may get lost in this vigorous and consequential GSE debate is ensuring that a well-performing, highly liquid capital market for multifamily rental housing continues. To date, single-family and homeownership housing finance policy have dominated the conversation, and with the single-family market still very fragile in many areas of the country, that will likely continue to be the case. To make sure that multifamily finance isn’t neglected, anyone who depends on getting reliable low-cost multifamily capital—especially the affordable housing community—will need to get seriously engaged in this debate about what we should do to reform mortgage finance.

How did we get here? When Congress passed the financial regulation reform bill—a.k.a. the Dodd-Frank Wall Street Reform and Consumer Protection Act—last summer, it postponed the issue of what to do with Fannie and Freddie, calling instead on the U.S. Department of the Treasury to come up with a plan by January 31, 2011 to reform them.

Meanwhile, Fannie and Freddie continue to operate under government conservatorship, something they have done since September 2008, shortly after Congress addressed regulating the GSEs in the Housing and Recovery Act of 2008 and during the height of the mortgage and financial crisis. Since entering conservatorship, the federal government has kept Fannie and Freddie afloat, covering all of their losses and ensuring that the housing market—both single-family and multifamily—continue to have access to mortgage capital. Private mortgage capital had essentially dried up in late 2008, and in early 2011, continues to come back slowly. This government lifeline—combined with the resurgence in the volume of Federal Housing Administration-insured loans—has resulted in the origination of nearly nine out of 10 single-family loans having some sort of government backing since the crisis began. As U.S. Department of Housing and Urban Development (HUD) Secretary Shaun Donovan noted in an August Treasury-sponsored symposium on the future of the GSEs, this is not a long-term sustainable situation.

This government lifeline is not going to last indefinitely, and Congress will have to decide how to end it. While there will be a great debate about how to end the lifeline for single-family mortgage finance, multifamily mortgage finance deserves attention as well.

The GSEs and Multifamily Rental Housing
Until the financial crisis, Fannie and Freddie were perhaps best known in the multifamily sector as the two largest investors in the low-income housing tax credit (LIHTC), representing approximately 40 percent of the annual LIHTC investment market. While it is not likely that Fannie and Freddie (or any possible successors) will emerge from reform to become LIHTC primary investors, Congress could choose to allow them to perform a role similar to what they do for single-family mortgages: help develop and maintain a liquid secondary market for LIHTC investments, allowing for shorter term investments to nontraditional investors who are unable or unwilling to invest for the full 15 years of the LIHTC compliance period. Such a secondary market could broaden the LIHTC investor base, making the program less vulnerable to market sector volatility and less subject to the geographic manifestations of Community Reinvestment Act-motivated investments by banks.

Much less well-known, but arguably more important is Fannie’s and Freddie’s role in the multifamily debt market. According to a recent report from the Center for American Progress, more than 84 percent of all multifamily loans originated in 2009 were purchased by Fannie and Freddie. Furthermore, of all multifamily mortgages outstanding, Fannie and Freddie owned 35 percent, almost triple the private nongovernmental MBS market (12 percent).

This is no accident, nor is it a result of the financial crisis. A significant portion of the multifamily finance market, both market rate and affordable, requires reliable, long-term, fixed-rate access to capital, and the private market is unlikely to do so without some sort of government involvement, especially in times of economic crisis.

Government involvement in multifamily finance costs taxpayers little, if anything. Fannie’s and Freddie’s multifamily performance has been largely profitable, and the government lifeline being used to prop them up and cover their losses has resulted from their single-family business. According to Recap Advisors, the multifamily foreclosure rate of both Fannie and Freddie is less than 1 percent, much lower than their single-family and the private label market multifamily foreclosure rate.

There are several multifamily policy issues that deserve attention in the GSE reform debate. One is how best to provide the multifamily sector access to long-term, fixed-rate permanent debt. Congress should provide the affordable housing community with access to credit-enhanced construction loans and specialized loan products for underserved markets: preservation transactions, small (five-to-50 unit) and rural properties, and special needs housing. And as originally envisioned by Congress in its previous GSE reform legislation, it should reaffirm Fannie’s and Freddie’s (or their successors’) obligation to help finance the National Housing Trust and Capital Magnet Funds, two crucial and innovative programs to help address the nation’s toughest affordable housing and community development challenges.

This is not to say that because these issues need to be addressed in the debates on GSE reform that Fannie and Freddie should be kept in their current form. If Congress decides to follow Rep. Frank’s suggestion and abolish Fannie and Freddie, then it should ensure that their successor(s) keep multifamily capital flowing to those that need it. We all need join in that debate.