Is the pursuit of the American Dream through homeownership just an elaborate bait and switch? It’s understandable why many might now think so. The collapse of the housing bubble has particularly devastated minority families who, after generations of discrimination in housing and mortgage lending, at last got a home of their own, only to find that it destroyed what little wealth they had.
But this disaster didn’t have to happen. With the right policies, homeownership could once again become a major avenue of broad upward mobility in American life, even for families with lower incomes. Proof of concept comes from an innovative community financial institution that has proven to be financially sustainable even as it has benefited lower-income home buyers throughout the collapsing real estate market of recent years.
In 1998, a credit union in Durham, North Carolina, started a project called the Community Advantage Program, or CAP, with money from the state government and a $50 million grant from the Ford Foundation. Its goal was to increase the flow of private capital to lower-income and minority borrowers. CAP purchased mortgage loans originated by banks that were seeking to satisfy the requirements of the Community Reinvestment Act, which mandates that banks make at least minimal loans (often to minorities) in their local communities. Eventually, CAP’s portfolio grew to more than 46,000 home-purchase mortgages made to lower-income households. Yet, despite what might be considered the risky profiles of its borrowers, CAP’s portfolio has weathered the storm, far exceeding the performance of the rest of the housing market during the recession. While nationwide, 15 percent of prime adjustable-rate mortgages and 20 percent of subprime fixed-rate mortgages have serious delinquencies, the CAP rate is only 9 percent. And CAP homeowners have seen a median annualized return on their equity of 27 percent, leading to a median increase in equity of close to $18,000, meaning that they were better off than investors in the Dow Jones over a similar time period.
Two lessons derive from the CAP experience.
First, product matters. If you sell people exploding mortgages, guess what—they are likely to get hurt. But if you connect them, as CAP did, with an appropriate mortgage product in a fair and transparent manner, most will do just fine. For many families, that old-fashioned, self-amortizing, thirty-year, fixed-rate mortgage does the trick. And to make it affordable for people of modest means, it’s perfectly okay to require only a modest down payment. Seventy-two percent of CAP’s loans had initial down payments of only 5 percent or less. There is no categorical reason why people who can’t afford a 20 percent down payment should have to pay higher interest rates, as some are now proposing.
It’s important, though, that home buyers, particularly those with lower incomes, have an honest and knowledgeable advocate to shepherd them through the process. Here, a network of support organizations operating in the nonprofit sector, including CAP, has a growing track record of success. They offer a range of services that includes financial education, help in establishing savings accounts, and assistance in finding appropriate mortgage products and negotiating mortgage modifications if necessary. Expanding the capacity of these organizations and institutionalizing their role in the mortgage process can help make homeownership work for a broader range of American families.
But that’s not enough. Going forward, broader reforms are also needed. It should be obvious by now that the mortgage marketplace needs adult supervision. Once regulators stopped paying attention, the market became overrun with subprime lenders. While in some instances this helped families with poor credit become homeowners, in most cases it simply trapped people into deals beyond their means with terms they did not understand. These predatory loans became the virus that infected the entire economy. The creation of the Consumer Financial Protection Bureau in 2010 was an important first step, but to be effective it must be protected from merciless attacks. Republicans in the last Congress, egged on by the financial sector, decided to play political games and make the president use a recess appointment to install former Ohio Attorney General Richard Cordray as its inaugural director. It is time to confirm him for a full term and let the CFPB do its job. (See John Gravois, “Too Important to Fail,” Washington Monthly, July/August 2012.)
Finally, we need to build a sustainable and transparent mechanism for assuring that mortgage credit continues to flow to creditworthy borrowers, especially to members of historically disadvantaged groups. Today, Fannie Mae and Freddie Mac remain in receivership and to date have cost taxpayers $150 billion. With roots that extend back to the 1930s, these firms pursued a range of practices that increased the availability of mortgage financing. But because their congressional charters called on them to make a profit, their main business became, like that of their competitors, slicing and dicing subprime mortgages into securities that they sold to unsuspecting investors around the world.
This pursuit of short-term profit maximization left Fannie and Freddie deeply exposed when the housing bubble popped. The key lesson learned is that it’s a bad idea to put federal housing subsidies in the hands of profit-seeking institutions. Instead, to ensure that responsible buyers can access private capital, government will have to embrace an expanded direct role in providing insurance on mortgages and setting standards on future loans. We can do this through a recapitalized Federal Housing Administration or a new set of public entities that take the place of Fannie and Freddie. Promoting homeownership among those of modest means is an appropriate goal of government, but it is time to be up-front and direct about how we pursue that obligation.