Most times when dealing with a major problem of national scale, the policy responses require huge sums of money. In fact, with the housing finance problem we're focusing on this week, the lack of a huge budget item makes it easier for the policy crowd to discount. Yet, small changes in federal rules -- changes that don't even require the approval of Congress to enact -- could unleash trillions of dollars of investment in struggling neighborhoods all over the country.
The RPA report -- The Unintended Consequences of Housing Finance -- details a number of policy actions that can be taken, but I'm going to distill it down to one primary reform and a few bonus alternatives to consider.
Primary Reform: Raise or eliminate the caps on non-residential floor area.
Nassim Taleb is the Patron Saint of Strong Towns Thinking and his concept of via negativa resonates with me. It is addition by subtraction, an acknowledgement that complex, adaptive systems have evolved a certain level of resilience that our tinkering rarely improves.
When we've intervened in these systems to make them better and the results are less than optimal, the proper response isn't to layer on more intervention. We should remove the intervention first and see what happens.
The people at Regional Plan Association who wrote the Unintended Consequences of Housing Finance report opted -- after some consideration -- to not recommend complete elimination of the caps. They recommend raising the caps, which is a politically pragmatic approach that I respect it. However, I don't think it goes far enough.
The eastern 20% of this country is filled with historic neighborhoods that have survived our post World War II development experiment. Many of these are thriving, but a high percent are struggling. These are mature places with three, four and greater story buildings that need some love. Raising the caps, as recommended in the report, addresses those needs.
As we move further west, however, the landscape changes. The percentage of potential mixed-use buildings that are one and two story jumps dramatically. The traditional Main Street building with retail on the ground level and housing on the second -- ubiquitous in downtowns of the Midwest and West -- would not conform to federal guidelines unless that cap were raised to at least 50%.
Why not eliminate the caps? If the federal government is going to be involved in insuring and subsidizing local real estate, why would we skew the market so far in one direction? It can only make things riskier, as our memories of 2008 should attest. A more diversified housing stock in a more competitive marketplace will not only provide better price signals, it will be less risky to insure.
I would like the caps eliminated. At the very least, they should be raised to 50%.
I like the notion of mitigating risk. If the federal government is going to be in the insurance game, let's make it function like insurance where risk is reflected in the price of premiums. If that were the case, mixed use neighborhoods -- which performed better in the recent housing crash -- are actually less risky and thus should get preferred rates.
The RPA report shows how we can mitigate risk even further. Ideas that I support include:
- Shorter loan periods. Go ahead and roll the loans over more frequently.
- Supplemental/secondary mortgage insurance for initial years of a project. These are the riskiest time period so get some extra insurance.
- Insurance against vacancy rates exceeding a stated level. If the commercial component fails to perform, there is a fallback.
I also think we need to acknowledge the complexity that mixed-use development entails. We can get our Rocket Mortgage with the click of a button because the assumption of the FHA, Fannie and Freddie -- and they are in an asymmetrical gamble with house money, no pun intended -- is that all housing is the same. We've reduced housing to a checklist and so, in many ways, it is.
Mixed use development is far more complex and hearkens back to a time when bankers had to get to know the people they lent to. It is local bankers that understand the nuance of a local market, the potential for success and the risks involved. I would like to see us deal with this complexity, not by regulation, but by having local banks keep more skin in the game on all loans.
We can still use Fannie and Freddie if we must (note that I would take away all of their government support, implied or otherwise), but let's have local banks keep 20% of the loan on their own books and only securitize the remaining 80%. That way we can have advantages of a secondary market while still ensuring that the incentives for those who perform due diligence on the loan are aligned with those who insure it and hold the debt (aka: American taxpayers).
Remove the regulatory caps that are distorting the market. Reduce risk by having shorter loan terms, targeted insurance and local skin-in-the-game. This costs nothing and would make a huge difference in the level of choice and opportunity Americans would have, particularly those left out of the current system. That's a Strong Towns approach.
If you think this topic is important, please let others know. You can follow all of our housing coverage at www.strongtowns.org/housing.