Richard F. Syron's Speech to the Federal Reserve Bank
of Boston and Rappaport Institute, Kennedy School
of Government on May 22, 2006

"The GSEs and Housing Affordability:
A Necessary But Not Sufficient Condition"

Prepared Remarks for Richard F. Syron
Chairman and CEO, Freddie Mac

Federal Reserve Bank of Boston and Rappaport Institute, Kennedy School of Government
Boston, Massachusetts
May 22, 2006

Thank you, Cathy [Minehan]. And thank you all for being here.

I have to confess it feels a bit ironic to be running a GSE, and keynoting a gathering co-sponsored by a Federal Reserve Bank.

After all, if you believe some of the talk in Washington, the GSEs and the Federal Reserve are supposed to be a bit like the snake and the mongoose.

So I want to thank the Boston Fed, as well as the Rappaport Institute and the Kennedy School, for inviting me. It's good to see so many old friends and former colleagues here.

The Boston Fed has a proud history of addressing thorny, difficult issues. And one of the many ways Cathy Minehan has done a great job is by extending and enhancing that honorable tradition.

I want to help continue that same tradition by taking on some tough issues this morning around the growing challenge of affordable housing. Some of what I say may be controversial.

The title of my remarks this morning is, "The GSEs and Housing Affordability: A Necessary But Not Sufficient Condition." You may be able to glimpse from that the essence of my thesis.

Is housing affordability a real and growing problem in this country? Absolutely.

Is there more the GSEs and the housing finance system could do for affordable housing? Of course. There's more we all could do.

But is housing finance the primary cause of the affordable housing shortage in America or in New England? Absolutely not.

First, I want to present evidence to you this morning that the housing GSEs are a part of the solution on affordable housing.

Second and perhaps more importantly, I want to discuss how, if we're going to be serious about making housing more affordable, we have to look at factors more fundamental than housing finance.

Afterwards, I'll be happy to discuss the forecast for housing in Q&A. And I look forward to answering all your other questions as well.

Let's start with what housing finance and the GSEs can do, and do well. Perhaps our most important macroeconomic function is to transfer interest rate risk away from the household sector. That's exactly what the long-term, fixed rate, prepayable mortgage does. It has a host of benefits for families – and it's a big advantage for our nation.

For example, recent research for the UK Treasury and the IMF shows that such fixed-rate lending makes a nation's economy less prone to boom and bust.¹

So why don't more countries have the fixed rate prepayable mortgage?

You can go to Detroit, and call mortgage brokers in the Windsor, Ontario phonebook, just a few hundred yards away. The longest fixed-rate loan you'll be able to get is less than 10 years – and even with that, you'll pay a substantial penalty if you want to prepay.

Why this difference? In fact, why is the US the only major economy in the world where this kind of mortgage is widespread? The biggest reason is the GSEs.

Joe Peek and James Wilcox have shown that the GSEs also benefit our economy by providing credit in a counter-cyclical way.² So that instead of being the sector most vulnerable to the economic cycle – as it once was – housing has become a pillar of the economy. And housing played a major role in keeping the 2001 recession mild and short.

When I was a young economist, you went hat in hand to the bank for a loan, and the attitude was "take it or leave it." Today, consumer choices abound; mortgage money is widely available across every region; homeownership is up; and financial transaction costs are low.

Freddie Mac is part of the reason for all this. We are a fairly unique organization: a publicly traded company with a federal charter. This charter defines our role as a provider of liquidity, stability and affordability to the housing finance markets.

As for liquidity, the GSEs excel at tapping the global financial markets to fund housing in America. As a result, mortgage-backed securities are the most widely traded non-sovereign instruments in the world. This is a huge and highly liquid market.

As for stability – and I'm summarizing a great deal here – the GSEs played a central role in steadying the mortgage markets following the 1998 international financial crisis; also following 9/11; and again today in the aftermath of Hurricane Katrina. To take just one more example, we also had a role in buffering the residential housing market from the same New England credit crunch that I saw hitting other sectors of the regional economy with full force when I had Cathy's job in the late '80s and early '90s.

As for affordability, a very visible part of our job is to fulfill the ever-increasing affordable housing goals set for us by HUD. For 2005 there were seven goals and sub-goals in all, covering such things as minority purchases and first-time homebuyers. We were able to report to HUD that we met them all.

Significantly, the majority of funding done through our retained portfolio helps to meet one or more of our affordable housing goals.

In just the last year or two, we've added many more affordable loan products. Some require as little as $500 in borrower funds. Some have special benefits for the police, firemen and teachers who serve our communities. Some help borrowers with problematic credit by automatically reducing the interest rate on the loan after two years of timely payments. Still others have interest-only or option-payment features appropriate for some qualified borrowers.

Freddie Mac has also taken strong steps to combat predatory lending in the industry. And our commitment to helping families keep the homes they buy has led us to research and implement a program in which delinquent borrowers who qualify and take part in a loan repayment plan can reduce their chances of losing their home due to foreclosure by up to 80 percent.

So there are very good things the GSEs can and are doing to make housing finance more affordable and fair. But let's not pretend the GSEs or the housing finance system as a whole can by themselves achieve housing affordability in this country.

For example, the answer cannot lie in simply ratcheting up the GSEs' affordable housing goals. First, there is a very real upper limit here before we're forced into behavior that would encourage predatory lending. Second, the GSEs' share of even the conventional conforming market has fallen. We lack the ability to influence enough of the market – all the more so in high-cost areas like Boston where the problem is most acute. So we can't even help most potential homeowners in the state of California – where the median home price of more than $560,000 is well above the conforming loan limit.³

The GSEs are the largest but only one of many programs on the housing finance side. And the power of the financing programs – even collectively – is limited.

It's no surprise that housing finance is where people have looked for the solution. For the most part, questions of housing finance haven't been anywhere near as tough politically as questions of housing supply.

Building more housing ... near existing homes ... now that's a hornet's nest.

But we have to ask: Have we achieved as much of our potential on the supply side as we have in housing finance?

There is a lot of persuasive research to indicate that we have not. And our common sense leads us in the same direction.

We need to confront a fundamental question on the supply side. Why does it cost so much, beyond the cost of land itself, to produce housing units? In looking for an answer, we're led to look at zoning, permitting and other restrictions on development.

Zoning serves important public purposes, such as separating dangerous industrial facilities from homes and schools. But it can also be used to restrict supply, keep prices high and ration who can live where. For example, Ed Glaeser, Director of the Rappaport Institute and a speaker on our first panel this morning, has done a great deal of interesting work, along with other researchers, on the effects of zoning and other local restrictions on housing prices and new housing supply.⁴ He defines the "zoning tax" as the portion of the value of a home due to zoning and land-use restrictions and not the intrinsic value of raw land or the structure.⁵ By his estimates, the zoning tax in Boston is over $140,000 per quarter acre.⁶ In other research on the greater Boston housing market, he has found that a quarter acre of land itself is worth about 20 times more if it sits under a new home than if it extends the lot size of an existing home – and concludes that the right to build is itself worth a great deal.⁷

In a related discussion paper, Glaeser concludes that the affordable housing debate should be broadened to include zoning. "Building a small number of subsidized housing units is likely to have a trivial impact on average housing prices (given any reasonable demand elasticity), even if well targeted toward deserving poor households. However, reducing the implied zoning tax on new construction could well have a massive impact on housing prices."⁸ (emphasis added)

The OECD has come to strikingly similar conclusions internationally. Looking at the United States and four other countries, it found that areas where housing prices rose the most were the same ones where man-made barriers to building new supply were highest.⁹

Related to zoning is the permitting process, which homebuilders and others have long argued adds both direct costs and costly delays to the price of housing.

The National Association of Home Builders conducted a survey in the summer of 1998. Using very different methodologies and data from the other research I've cited, they found results strikingly consistent with the thesis that the greatest man-made barriers to building exist in those areas where house prices have risen the most.

The Home Builders found: "In San Francisco, for example, an estimated 28.6 percent of the sales price [of a new home] could be trimmed if the regulatory process was reformed and streamlined; in Grand Rapids, Mich., the sales price could be cut by about 4 percent."¹⁰

Now, I'm not taking any particular position in the smart-growth, no-growth, whatever-growth debate. I'm not allying myself with any scholar or school of thought. And I'm not saying Brookline and Palo Alto have to become Houston.

It's perfectly reasonable for successful people – not unlike those in this room – to seek to live around others who can also afford the amenities and trappings of success. But the role of public policy has to let us see externalities and factors beyond our parochial interests.

We can't be hypocrites about this. We can't say we want housing to be more affordable, yet fight like the devil against any changes in local rules that could conceivably diminish our property values in the short term.

On Cape Cod, my wife and I own a summer home in Osterville, and a new project with affordable housing was proposed about half a mile away. Like everyone else, I had some qualms about its effect on my property value. But I supported the project. Because how can I be for affordable housing all week and then turn around and be against it over the weekend?

Obviously, families who can't afford to own or rent a decent home in an area are harmed by zoning and other restrictions that make it more costly to add to supply. Another, less obvious externality, is that businesses in the area are harmed – as is the local economy.

We all know that job growth in Eastern Massachusetts is not what it could be. The high cost of housing and living here is a significant reason.

And Greater Boston illustrates a larger phenomenon. Nationwide, a 1 percent change in labor demand increases wages by roughly 0.25 percent more in metro areas with heavy land-use restrictions than in those with light restrictions. But the same change in labor demand increases house prices by over 1.75 percent more in the metros with heavy restrictions.¹¹

Well, why don't we just build further out? We have been. But punishing commutes, high gas prices and environmental concerns are testing the limits of this approach. Already, a third of Boston area households live at least 30 miles from the central business district. And it's a remarkable commentary that the Metropolitan Statistical Area for Washington, DC now extends into West Virginia.¹² We have a lot of people who commute from there.

We're seeing another phenomenon related to where we live that is also revealing and disturbing. Namely, the explosion in gated communities and similar arrangements.

More and more today, people are able to reflect their economic outcomes geographically, so that higher income people only mix with higher income people. That's a change from the America many of us grew up in. Are we sure it's a change for the better?

By some estimates, as many as 50 million Americans today live in communities that are either physically gated or extensively self-ruled. By contrast, only 200 of 16,000 "permit issuing places" have "inclusionary zoning" aimed at distributing affordable housing.¹³ So the human desire to exclude from our midst those who are less affluent or different would seem to be much stronger than the desire to include them.

We lose something when so many people and communities withdraw from the larger society. Indeed, we lose something of what it means to be an American.

Now, you can say this is all just the primacy of consumer choice as expressed in a free market system. But there's a political issue as well – when individual and local decisions, taken together, so consistently fail to maximize our total well-being as a society. This is precisely what many people here have pointed out.

I won't pretend the questions I'm putting on the table are no-brainers or small potatoes. On the contrary. These hard choices we're talking about today say a lot about the kind of society we want to live in.

Finally, we can't talk about how much money it costs to supply a home, without also considering how much money families have to buy one.

In the United States, between 1995 and 2003, the median homeowner's income increased by 30% while the median home price grew 61%. In Boston, during the same period, the median homeowner's income increased by 25% while the median home price grew 93%. So while the country as a whole strained to keep up, Boston fell behind even more.¹⁴

As many have observed, the problem with poor people is they don't have enough money. So one angle of attack on housing affordability that we can't afford to ignore is improving the prospects for the bottom half of the income distribution.

You may find it surprising to hear a CEO express concern about what one book calls "The Winner-Take-All Society," where the rewards increasingly go to the people at the top.¹⁵ But the fact is, increasing income inequality directly relates to decreasing housing affordability.

In the last several years, mortgage rates have been so low – thanks to low interest rates and mortgage innovations – that a lot of homeowners have been able to keep up, even as home prices rose rapidly. But that trend could not continue forever, and home lenders took it about as far is they could.

All of which means, we have to enlarge the discussion of how to achieve housing affordability. And just a few of the issues we have to consider as part of this broadened discussion include greater educational opportunities, comprehensive health policy, and improved public transportation connecting jobs to where people live.

We need to attack housing affordability with a full-court press of this kind. For we know that homeownership is the most democratic means we have as a nation for building wealth and building up a strong middle class.¹⁶

Conclusion

I'm not trying to be social critic in chief here. And I'm also NOT passing the buck for the GSEs:  We should do our part, perform our mission and report accurately and transparently to all our various constituencies. Is there more we can do for housing affordability? You bet. There's more we all could do.

Still, the overarching point is fairly clear. Housing finance – with a secondary market built around the GSEs – has done a great deal to make housing more affordable in this country. Ours is the only major economy in the world where the average household with decent credit can get a 30- or even 15-year fixed rate loan, at rates rivaling those that AA rated corporations get for their debt – and also have the option to prepay at no explicit cost. It's pretty extraordinary when you think about it. The cost and widespread availability of mortgage money is simply not the main problem here.

So what I'm suggesting is, are we looking in all the wrong places for solutions? If reducing the implied zoning tax will have a "massive" impact on housing prices, let's experiment with some of that. If we need to reduce the time, uncertainty and expense of the permitting process, let's try some ways to do that. If we need to experiment with infill proposals such as the "greenway" ideas for the San Francisco Bay Area, which increase densities yet are still sensitive to environmental concerns, let's do some of that. If we need to discourage NIMBYism, as I've suggested, let's certainly do so. And if increasing incomes for the less well-off will help, let's include that in the housing policy mix as well.

The housing finance system and the GSEs, working on the demand side, cannot make up for all the heavy lifting that's yet to be done on the supply side. We clearly can't – not by a long shot – and we ought to have a little humility. For the more hung up the Washington debate gets on radical fixes to the GSEs, the more energy gets diverted from where we as a nation can really make the longest strides towards housing affordability. Which is in the kinds of areas I've been talking about this morning – and what today's panelists will be discussing.

I will end where I began, by commending the organizers of this apt and timely discussion. Because out of more than a dozen speakers and panelists this morning, you've got only one from the field of housing finance. And that's about the right number.

Thank you very much. I'm happy to take your questions.

ENDNOTES:

1. "The UK Mortgage Market: Taking a Longer-Term View" (Final Report and Recommendations for H.M. Treasury) by David Miles, 2004 and "World Economic Outlook: The Global Demographic Transition," The International Monetary Fund, September 2004, pp. 71-89.
2. "Secondary Mortgage Markets, GSEs, and the Changing Cyclicality of Mortgage Flows" by Joe Peek and James A. Wilcox, Research in Finance, Volume 20, pp. 61-80, 2003.
3. Data represent March 2006 median home sales price for single-family detached homes."California Housing Market @ A Glance," California Association of Realtors (accessed May 19, 2006 at http://www.car.org/index.php?id=MzE3ODY=).
4. See for example "Regulation and the Rise of Housing Prices in Greater Boston" by Edward L. Glaeser, Jenny Schuetz, and Bryce Ward, Cambridge: Rappaport Institute for Greater Boston, Harvard University and Boston: Pioneer Institute for Public Policy Research; "Zoning's Steep Price" by Edward L. Glaeser and Joseph Gyourko, Regulation, Fall 2002, pp. 24-30; "Why Have Housing Prices Gone Up?" by Edward L. Glaeser, Joseph Gyourko and Raven E. Saks, Harvard Institute of Economic Research Discussion Paper Number 2061, February 2005. See also "An Economic History of Zoning and a Cure for its Exclusionary Effects" by William A. Fischel, Urban Studies, Vol. 41, No. 2, 317–340, February 2004.
5. "Zoning's Steep Price" by Edward L. Glaeser and Joseph Gyourko, Regulation, Fall 2002, p. 26.
6. "Zoning's Steep Price" by Edward L. Glaeser and Joseph Gyourko, Regulation, Fall 2002, pp. 27-28. Cost tabulated from Boston figures for the extensive margin or"Zoning Tax" of $13.16/square foot presented in Table 4 times the square-footage contained in one-quarter acre (10,890 square feet).
7. Glaeser, Edward and Joseph Gyourko,"The Impact of Zoning on Housing Affordability, "Economic Policy Review, Volume 9 Number 2, pp. 21-39, 2003.
8. "Zoning's Steep Price" by Edward L. Glaeser and Joseph Gyourko, Regulation, Fall 2002, p. 30.
9. OECD Economic Outlook Number 78, "Recent House Price Developments: the Role of Fundamentals," pp. 210-211 (Preliminary Edition, November 2005).
10. "The Truth About Regulatory Barriers To Housing Affordability," A Publication of the National Association of Home Builders, 1998.
11. State of the Nation's Housing 2005. Harvard Joint Center for Housing Studies, p.7.
12. State of the Nation's Housing 2005. Harvard Joint Center for Housing Studies, p.7.
13. "The Impact of Housing on Community," by Alexander von Hoffman, Eric S. Belsky and Kwan Lee, Working Paper W06-1 from Harvard Joint Center on Housing Studies, March 2006.
14. U.S. Department of Housing and Urban Development, American Housing Survey, National File 1995 and 2003 and Federal Housing Finance Board, Monthly Interest Rate Survey 1995 and 2003.
15. Robert H. Frank and Philip J. Cook, The Winner-Take-All-Society: Why the Few at the Top Get So Much More Than the Rest of Us, Penguin Books: New York. 1995.
16. Roughly $11 trillion of $50 trillion in US net worth today is home equity. (See Board of Governors of the Federal Reserve System, Flow of Funds Accounts for the United States, March 9, 2006). Yet for most homeowning families, it is more than half of their net worth. And home equity wealth in America is far more widely distributed by income than, for example, stock market wealth. (See Board of Governors of the Federal Reserve System, Survey of Consumer Finances, 2001 and 2004).