Inside Economics welcomes back Mark Calabria, the former director of the Federal Housing Finance Agency. We discuss the current housing affordability crisis and what policymakers should do to address it, the FHFA’s response to the COVID-19 pandemic, and the risks posed by nonbank mortgage companies. The group also takes up the role of the Federal Home Loan Banks. Plenty of debate, and even some agreement.
Inside Economics welcomes back Mark Calabria, the former director of the Federal Housing Finance Agency. We discuss the current housing affordability crisis and what policymakers should do to address it, the FHFA’s response to the COVID-19 pandemic, and the risks posed by nonbank mortgage companies. The group also takes up the role of the Federal Home Loan Banks. Plenty of debate, and even some agreement.
For more info on Mark Calabria
For more info on Mark Calabria's book, Shelter from the Storm, click here
Follow Mark Zandi @MarkZandi, Cris deRitis @MiddleWayEcon, and Marisa DiNatale on LinkedIn for additional insight.
Mark Zandi: Welcome to Inside Economics. I'm Mark Zandi, the Chief Economist of Moody's Analytics, and I'm joined by my two trusty co-hosts, Cris deRitis and Marissa DiNatale. Hi, guys.
Cris deRitis: Hi Mark.
Marisa DiNatale: Morning, Mark.
Mark Zandi: What's going on?
Cris deRitis: The usual, stress testing stress.
Mark Zandi: Yeah, the stress tests are underway. I think we've made pretty good progress. We have a webinar this afternoon, right?
Cris deRitis: We do. We've made excellent progress, really, kudos to the team.
Mark Zandi: Right.
Cris deRitis: Really stepped up.
Mark Zandi: Right. There's a lot to talk about in that CCAR stress test, but we'll wait for the webinar to do that.
Cris deRitis: Yeah.
Mark Zandi: I was in Miami last night speaking to a bunch of real estate folks and made my way back to Vero this morning. And I have AT&T cell service, that went down. I don't know about you guys, but if I don't have my cell working, somehow I feel naked, literally. I try, I have no clothes on, and I have my cell phone. Really, very, very disconcerting feeling. And of course I was thinking it was my phone, not AT&T, and then I heard on the radio, because I had the radio on, that I guess the whole network is down or a big part of the network was down.
Marisa DiNatale: Wow. Still the-
Cris deRitis: Do you have a paper map in your car, there?
Mark Zandi: I don't. You know, I used to religiously keep-
Cris deRitis: Yeah.
Mark Zandi: ... maps, but when's the last time you looked at a map? You mean a paper copy map?
Cris deRitis: Like a roadmap, map?
Mark Zandi: Yeah, like that.
Cris deRitis: Can't remember.
Mark Zandi: Yeah. Well, we've got a guest, Mark Calabria. Mark, good to see you again.
Mark Calabria: Pleasure to be here, as always.
Mark Zandi: Yeah. And I'm trying to remember, you were on, when was that?
Mark Calabria: A year ago or something like that, nine, 12 months ago, sometime.
Mark Zandi: Really? That long ago.
Mark Calabria: It may have been sooner. I don't look at maps. I don't look at calendars, either. So I'll-
Mark Zandi: You're a lucky man. You're a lucky man. Yeah. I'm wedded to that cell phone. But it's good to have you back on. And I think always a lot to talk about in the housing, mortgage, finance space. And last go around, we didn't really have an opportunity to talk about the book you wrote in any detail, it's Shelter from-
Mark Calabria: ... the Storm-
Mark Zandi: ... the Storm.
Mark Calabria: How a COVID Mortgage Meltdown was Averted.
Mark Zandi: Right. And you go through your leadership at FHFA, the regulator for Fannie Mae and Freddie Mac, and you were there under the Trump administration, when the pandemic hit, and obviously a lot of turmoil, and your book is about how you dealt with that and the policy you put into place, so I want to talk about that. How's the book doing, do you know?
Mark Calabria: It's, well, surprisingly hard to get accurate sales numbers on a regular basis, because of the different channels, but the feedback has been terrific, surprisingly, in some sectors, because there are things in the book that I think are somewhat critical of parts of the mortgage sector, and yet the response has been pretty positive. And I try to make the criticism constructive. So I've been very happy. Now, my takeaway is not that I'll never do another book again. I guess I'll put it this way.
Mark Zandi: That's not your takeaway?
Mark Calabria: It's not my takeaway.
Mark Zandi: Okay.
Mark Calabria: I feel like, as you know from having written book books, a lot goes into it, and as you know as well, you put as much energy into the marketing as you do into the writing, it seems.
Mark Zandi: Yeah, for sure.
Mark Calabria: But I had an-
Mark Zandi: The metaphor I have in my mind with regard to book writing is running a marathon, right?
Mark Calabria: Yeah.
Mark Zandi: It's very, very painful while you're doing it. But once the book is done, you go, "Oh, I- " [inaudible 00:04:11]
Mark Calabria: Once you've crossed the finish line, and of course like a marathon, it's not done until you cross the finish line.
Mark Zandi: That's true. That's true. That's very true. That's very true. Well, we'll come back to the book, because I want to talk first about, and I think we did this when you were on previously, oh, and I should say, obviously, you're at Cato now, right?
Mark Calabria: Yep. The Cato-
Mark Zandi: You're now at Cato.
Mark Calabria: ... Institute in Washington.
Mark Zandi: Yeah. Anything else in your remit? You want bring up anything about the-
Mark Calabria: Not necessarily. I think that's a good focus.
Mark Zandi: Okay. Yeah. And I don't know that the housing market's changed all that much since the last time we talked, pretty vexed. Although today we get the existing home sales for the month of January. I guess we haven't gotten them yet, but obviously it just feels like the housing market is in a very weird place.
Mark Calabria: It does, and sitting in Florida, I'll be curious. I really think of 2023 as a year of multiple lines of divergence. Single-family constructions go on this way, but multifamilies going this way, existing new sales doing different crazy things, but just as much California deflating while Florida is still going like gangbusters. I have a cousin who's a realtor in the Parkland Plantation area, and I talk to him regularly, and certainly has still saw a lot of traffic in South Florida for 2023. But my gut is, and I think we're already starting to see signs of this, that I think we're going to start to see a little bit of convergence back to normal trends, where this may be the year where Florida starts to revert to where the rest of the country has been going. And again, since you're there, I would be curious whether you feel like you're seeing that already.
And I do think we've had a couple of years of where new homes have made an outsized percentage of sales, and I don't think we're going to get back completely to trend, but I think we're headed that direction, where you're going to see more existing inventory come back onto the market. And again, new sales will still play an outsized role, but maybe less so. So while divergence was kind of my theme for 2023, I think a little more convergence is what I think we're going to see in 2024.
Mark Zandi: Hey, yeah, Cris, what's going on in the Florida market? I know you follow that carefully.
Cris deRitis: Yeah, it does look as though we're seeing some pressure. The rising homeowner insurance seems to be having more and more of an impact. That had been a bit of a mystery, but I think now, given the higher interest rates that borrowers are realizing the total cost of ownership there is high. We are seeing some increase in months supply in those areas. I think Vero Beach actually has very high level of month supply-
Mark Zandi: Really?
Cris deRitis: ... by our calculations. So I don't know if you're seeing that. But-
Mark Zandi: Well, the-
Cris deRitis: ... relative to this is-
Mark Zandi: ... home right next to me just transacted. I can't wait to see what the price was. I'm not sure what it was. But literally right next door, that home just sold, so interesting. But inventories are up. I didn't know that. Interesting.
Cris deRitis: Yeah. Across the Metro, maybe not in your-
Mark Zandi: Yeah, in my street-
Cris deRitis: ... little-
Mark Zandi: ... is all I care about.
Cris deRitis: ... enclave, there.
Mark Calabria: There's the 83 premium that goes that-
Mark Zandi: It's so funny, Mark. I got a great story. So I bought this home back in 2007, I think, maybe it was early 2008. It was after the first leg down in house prices. This was the financial crisis, you know, the beginnings of the-
Mark Calabria: Oh, yeah.
Mark Zandi: And my neighbor at the time comes over, says, "Hi, I just wanted to say hello. And we're very happy you came to the neighborhood, because given that you're an economist, we now all feel like this has got to be the bottom in house prices." Of course, prices fell another 25% after that.
Mark Calabria: I'm not going to claim timing, but my current house I bought in 2010, and if you map it out, it's almost exactly at the bottom. Again, more-
Mark Zandi: Oh, that's great.
Mark Calabria: ... luck, more luck than anything else.
Mark Zandi: Great. Well-
Mark Calabria: And I was going to say, I sold a rental in spring of '22, so I guess that was where I thought the rental market was going to be going afterwards.
Mark Zandi: Yeah, you-
Mark Calabria: So the caveat of nobody should really try to time their real estate market. It's tough.
Mark Zandi: It's pretty tough.
Mark Calabria: You get occasionally lucky.
Mark Zandi: It's tough. Yeah, of course prices have risen, so I don't feel so bad now that I've held onto it, and now I use the home, so that's good, too. But nonetheless, I go, "Gee whiz." But anyway, convergence. Is that possible, though, in the context of how poor single-family housing affordability really is? If you look at where mortgage rates are at 7%, even no recession, we're getting income gains, and given where house prices are, they fell a bit in '22, they rose a bit in '23, and they're still extraordinarily high. Here's a factoid-
Mark Calabria: Or-
Mark Zandi: ... for you. The median price of a new home is equal to a median price of an existing home, and that rarely ever happens. It rarely-
Mark Calabria: Exactly. You've seen builders start to, you know, try to target that lower end of the market, and-
Mark Zandi: Mm-hmm.
Mark Calabria: That's their response to the lack of existing inventory. So as my realtor friends always like to say, "Location, location, location." And when I say convergence, what I really mean is I think you're going to start to see some of the common trends. So it's more a case of, as was mentioned by Cris, inventories building up in Florida. I think at least at a minimum, price appreciation's slow, if not actually turned negative in parts of Florida. And you've already seen that, for instance, in lots of parts of California, you see it in places like Boise, where there was a lot of in-migration during COVID. And I also kind of think that while 2022, I mean 2023, rather, we saw the first couple of innings in a correction in multifamily construction. You haven't seen that in single family.
And so in a sense, I think what you've seen in terms of the markets that have been correcting, the rest of the markets that haven't really corrected, or many of them, I think are going to start to converge in that direction. So that's what I mean. And that's not to say, I mean as you know, one of my great frustrations I feel like I hear in the commentary is people often say, "Well, you know, supply's limited, therefore prices- "
Mark Zandi: Mm-hmm.
Mark Calabria: " ... can't fall." And my response is always, "Let's go back to our Econ 101 and remember." And if we want to be very simple about it and say, "In many markets housing supply is essentially inelastic in the short run." Which of course means we've got a vertical supply curve. And what that suggests to me is changes in demand can have relatively large changes in prices even without a movement in supply.
And there has certainly been offsetting factors. We've seen record immigration numbers, for instance, in the last year, that's kept up demand. There's been income growth, people are still down COVID savings. So demand has been strong. But at some point, if you see a weakening in demand, even without additional supply on the market, which of course in places like Florida, we are seeing additional supply. I think you can get price declines in some markets.
But again, I really emphasize it's going to be localized. As long as the job market continues, then I think the housing market will be fine. And ultimately it's a good reminder. I'm more of the school of interest rates and underwriting matter in the short run. But ultimately for the housing market, it's household growth, it's the underlying demographics, it's income growth, it's job growth. And those things in my view tend to dominate everything else.
Mark Zandi: But on the supply side, of course there's two aspects to that. One is the interest rate lock, meaning you got a lot of homeowners with a mortgage that has a very low rate they locked in prior to the run-up in rates. And I think the average coupon on an existing mortgage is 3.5%. And the current-
Mark Calabria: It's kind of crazy. Yeah.
Mark Zandi: Yeah. The current mortgage rate's seven, so they're locked or feels like they're locked for a while, until their demographic needs change to such a point that they-
Mark Calabria: Life-
Mark Zandi: ... have no choice.
Mark Calabria: ... life events and such. Yeah.
Mark Zandi: Life events. And the other is in the physical market, just the number of homes, single multifamily manufactured housing that's going up relative to that demand, household formation, obsolescence, and second vacation homes, it feels like the shortfall is pretty severe. And you can see it in the vacancy rates. The homeowner vacancy rate's at a record low, so it feels like it's also physical, it's also supply too, though, no?
Mark Calabria: There absolutely is a supply constraint, but I'll just, again, the more inelastic supply, the bigger the magnitude of price changes with any one given change in demand. There are elements. We've been building more multifamily since we have in the '70s. And you've actually, interestingly enough, seen a rather large increase in the number of for rent properties that are being held off the market. And what a lot of people are doing is instead of selling that home in which they're three and a half, they're moving, and taking a new job, and renting it. And I'd be the first to say, I think you could go a number of years where you see softness in the rental market and in Metro before it starts to show up in homeownership.
But I do think that there's pressure. When the options to rent are so much cheaper in a metro, you trying to track first time home buyers is pressure on that. And again, there's a lag there, but I think we really have started to see a lot of supply on the rental market come on. And the question is ultimately what's the lag in terms of impact in the single family market from that? So that's where I'm looking at it. I can't remember whether it was you or one of my other forecaster friends who came up with the, "Give a number, give a date, but never give both."
Mark Zandi: Yeah. I know.
Mark Calabria: And so this is one of those things where-
Mark Zandi: I'd never say that. I'd never-
Marisa DiNatale: It wasn't Mark.
Mark Zandi: Wasn't me.
Mark Calabria: It wasn't Mark.
Mark Zandi: Yeah.
Mark Calabria: You always do both.
Mark Zandi: I'll do all of the-
Mark Calabria: You always-
Mark Zandi: ... above.
Mark Calabria: ... do both.
Mark Zandi: Yeah.
Mark Calabria: Which should be applauded. But so in this case, these are the trends I see playing out, and certainly in the multifamily. I guess what I really want to distinguish is it's certainly possible, and we are in a case where I would say there is a trend structural shortage, but I think you could be in the case with a cyclical, you're getting to a part in the rental market, in my opinion, where we're oversupplied in the cyclical point of view, which doesn't mean we don't mean we don't need more housing overall, ultimately.
Mark Zandi: Yeah, on that, and I may have this wrong, but the narrative I have in my mind on the multifamily supply, and you're right, there's a lot of supply coming. I think there's a million multifamily units, almost on the nose, in the pipeline going to completion that got bottled up because of the pandemic supply chain issues, labor market issues, but they've been resolved and now the supply's coming in. But that feels like that's all at the high end of the multifamily market, the lifestyle rental, the big apartment towers and- [inaudible 00:16:09]
Mark Calabria: Sure, but ultimately it filters down. If you can move up from a C, D property into an A property, that's going to put pressure. Again, we'll start with one of my favorite factoids to the extent that it is a factoid, which is every new home on average results in about four moves as people move up. There is a housing ladder. We have broken it in many parts of the countries, but the concept does exist. And I would argue there is a rental quality ladder as well, where not everybody goes immediately from their parents' basement to a luxury rental. And again, you're right in that most of the construction is either assisted, so my gut is probably about 50 to 60% of apartment construction now is tax credit driven. So there's a huge part of this that is subsidized, that is supposed to be readily available for median or below median income. Certainly almost all of the unsubsidized rental is at the top end. But again, that allows someone to move up from a B property to a C property, which puts downward pressure on the B property. So I do-
Mark Zandi: Let's-
Mark Calabria: ... think you're ... Yeah.
Mark Zandi: Oh, go ahead. Go ahead, Mark. Sorry. No.
Mark Calabria: But I do think you're going to start to see rents softening, again, location, location, location. This is going to differ by market. And so I think this is something you're going to start to see and have seen in a number of markets already, and that's going to make homeownership less attractive at the margin for a number of households.
Mark Zandi: The housing affordability, let's call it, many would, crisis, which goes in part to the shortage of homes, both on a single family and a rental side, caught policymakers' attention. And there's a piece of tax legislation finding its way through the legislative process. This is child tax credit, this is R&D tax credit, and in that legislation is juicing up LIHTC, low income housing tax credit, you just alluded to.
Mark Calabria: Yeah. And this is a great point. I'll say up front, I'm not a huge LIHTC fan. I know that that leaves me as an outlier. I know it's much beloved, especially in Washington. First of all, it's presented, and I understand the reason it's presented this way, as a supply subsidy. But if you really think about it, and again, I think often you and I might arrive sometimes at different observations because of the difference of being a micro versus a macroeconomist, and-
Mark Zandi: Top down versus bottom up. Yeah.
Mark Calabria: And so I really think about like, "Okay, you're injecting the subsidy into a supply chain. What's the relatively fixed factor of production?" And in this case it's developable land. It's not the equity. So ultimately, if you think about what really is going to filter through in terms of if you increase the tax credit, it's going to allow developers to bid higher prices for the developable land. So it'll be great if you own developable land in places of California, an expansion of tax credit will be very good for you. You will capture most of those subsidies. You also have a process where in many places the tax credit process results in properties that are no cheaper to do than unsubsidized. And you have the labor rules that are involved. You have a number of different other requirements. These properties tend to have four to eight total subsidies, it's rarely just a tax credit, and each one requires an application and a set of lawyers.
It's just not a terribly efficient delivery vehicle for subsidy in my view. And again, one of the reasons it's popular because, as I mentioned, everybody gets a piece, labor gets a piece, lawyers get the piece, the Wall Street syndicators get a piece, the developer gets a piece. So on one hand it's a perfectly structured political program. It's just not a program, in my opinion, that actually on net ads. And as we talked about in the luxury end, it does end up, there been a number of academic peer-reviewed studies, good journals, you get about 50%, 60% displacement where the tax credit property comes online, and then a lower quality property leaves leaves the stock. So it does, probably the most important thing if you wanted to be a big advocate for the program is it definitely upgrades the quality of assisted housing.
So that's probably the most immediate effect, is a quality impact rather than a quantity impact. And so again, I guess I'd put it this way, it's not even necessarily a matter of spending. If you had, let's just say it's a couple of billion, I think you'd make a bigger impact spending the exact same amount of dollars on vouchers than you would on tax credit, and I understand given the supply constraints. The other thing that, my knock on the tax credit program, so here's a factor that may surprise you, but not given you're in Florida, over 50% of renters live in properties of under five units. And the median tax credit property size is about 40 units. So if much of the pressure we're seeing in affordability is not simply New York City, but also suburban areas or rural areas, again, not saying there are no tax credit developments in rural America, but there are very few compared to it. So you're leaving out a very large segment of renters.
And I would also say as a cyclical point, is this really the point in the cycle where you want to add more subsidy to multifamily development? Again, part of this is separating out the trends from the cyclical component in multifamily. I would also say as an aside, and this is more my experience in government, I really don't like spending through the tax code, partly because you've hardwired it and you've set it, you've made it much difficult to change. And at the end of the day, our country's needs change from year to year. Who am I to say that next year the marginal dollars shouldn't go to education or healthcare? So why? When you lock it into the tax code, you reduce flexibility. And I like to have flexibility to address the ever-changing needs of our country.
Mark Zandi: Whoa, there's a lot to unpack, there.
Mark Calabria: Of course.
Mark Zandi: Really, that's a whole nother podcast. Holy cow. But Cris, any reaction to what Mark said, any piece of that you want to tackle?
Cris deRitis: I'm sympathetic to much of the view. There are a lot of academic studies. I recall, they were early 2000s, when I was reading them, but I'm assuming they're still valid, that showed that there's a large substitution effect with LIHTC that just are substituting a lot of private investment for this subsidized product. So I think there's certainly-
Mark Zandi: I didn't know-
Cris deRitis: ... something,
Mark Zandi: ... you were a Cato kind of guy, Cris.
Mark Calabria: It's just what the studies say.
Cris deRitis: Just a realist.
Mark Calabria: Look.
Cris deRitis: I'm not against, I'm not-
Mark Calabria: Look.
Cris deRitis: ... perhaps as adamantly against providing subsidy.
Mark Zandi: Right.
Cris deRitis: I just don't know that this program is as effective as it's made out to be, I think- [inaudible 00:23:52]
Mark Zandi: Well, I make a political economy argument that is, look, no policy is perfect. All policy has unintended consequences, issues, whatever, things that mitigate the effectiveness of the policy. But in the current context, tell me what better solution do we have to address what I consider to be a crisis with regard to affordable rental? People, that's part of the reason why homelessness is such a problem as it is today. The cost of renting is just out of bounds for many American households. We need more supply. Yeah, sure, there's going to be some substitution, and yeah, you're right, it may cause land prices to rise in certain parts of the country. But LIHTC is coast to coast. It's not just California. It's not just Florida, it's rural Texas, it's all over the country that we need the housing.
And to your point about tax subsidies, most tax subsidies, including the one that's in this piece of tax legislation that we're debating now, expire, and you get a debate, and you come right back to it. Right now we're back talking about R&D tax credits. We're back talking about child tax credits, and there's no guarantee that it's going to be passed. And in fact, these things have been delayed to a passage. So this is a very good way of reevaluating what kind of policies you need.
Mark Calabria: Yeah, there are elements of the tax code that are quasi-permanent. There are some that come up pretty regularly, and generally that's driven by scoring issues and what Congress needs to do at the moment. But first, I am a glass half full guy. And so let me start out with, I've really been heartened by much of the conversations in many states and localities about dealing with restrictions on supply, because ultimately it's extremely hard for Washington to fix this problem, because supply constraints. And so what's being done in Montana? What's being discussed, what's been done in Minneapolis? What's been discussed in California, and some of the changes that have been made?
And so as Cris may remember, 25 years ago, it was only a bunch of economists talking among themselves about zoning and supply restrictions. And now this is a mainstreamed conversation, and not just a mainstreamed conversation that has entered general consciousness but has actually resulted in legislative changes in a number of localities. And if you don't fix that, I do worry that a lot of Washington responses, you have a hammer and therefore everything looks like a nail. And much of Washington's housing policy infrastructure was created during the Great Depression to deal with perceived demand insufficiency.
And again, if you have policies that you think are there to manage aggregate demand in an environment of fixed supply, you get inflation. And so I am optimistic in that we've really seen these conversations and policy changes at the local level. Unfortunately, there's been backlash. You see places like Austin that are moving in the wrong direction because Texas has been such a magnet for in-migration. But you also see, again, somebody who's been following these issues for 25 years, the conversation in Washington has much more a land use component in part of the discussion than it did 10, 20 years ago. And I think that's a positive. So you got to deal with that issue. As I mentioned, for instance, one of the more successful programs, so again, this is not a Cato everything bad, it's more a what's least bad, if you will, or what's most impactful?
I actually think the way the HOME program works at HUD is the right model because it allows you to do development, it allows you to do vouchers, it allows you to pay security deposits. It really has a tremendous amount of flexibility. And as you know, a significant amount of the tax credit program does go for rehab, which is useful for some markets. And it really is just, I come from the place of this is all location driven and many markets do have supply constraints, not everyone do. Many markets, they won't support the density that's normally required, in rural Texas, as you mentioned. So I would rather, again, even if you spent the exact same amount of money, I'd rather see you go through the HOME program because I think that gives more flexibility.
Mark Zandi: Yeah, I hear you. And all- [inaudible 00:28:32]
Mark Calabria: The political dynamics-
Mark Zandi: ... demand-
Mark Calabria: ... are-
Mark Zandi: Yeah, on the demand side, particularly in the current context with the supply, in my view, the supply curve is, using your language, very inelastic for lots of reasons that are hard to address. But we've got a housing problem right now, but I agree we shouldn't layer on top of inelastic supply curve juice to demand. That would be, you know, all that-
Mark Calabria: Yeah. And-
Mark Zandi: ... does is-
Mark Calabria: And this is one reason I have been critical of some of the other, we have seen record construction in manufacturing, many around CHIPs, and other facilities, but that competes directly with the labor you're going to need to build housing and other infrastructure. And so we have to make choices about whether this is the right time to build what? And of course, you lost a lot of construction labor during the 2008 crisis. I like to think I'm doing my part. My nephew is working on his journeyman's in plumbing and is doing-
Mark Zandi: We need him.
Mark Calabria: ... out there, and ... We do.
Mark Zandi: We need a lot more of them, yeah.
Mark Calabria: And I think that needs to be part of the conversation. I guess I should preface with, I know at least you and I, and maybe the other two as well, but I just find it weird, a guy with a PhD say, "We need more people not going to college and more people going to vocational school." But we do.
Cris deRitis: Right.
Mark Zandi: We do.
Mark Calabria: We do, with those certain important parts of the economy. You know? So that's-
Mark Zandi: Yeah. [inaudible 00:30:02]-
Mark Calabria: But the overall, I agree that I think we have a housing affordability crisis in most of America, and it's just really, how do you address it?
Mark Zandi: Yeah. I want to move the conversation forward a little bit and get to the FHFA, when you were running the show there. Before I do that, just one quick question, and this may be outside your remit. But-
Mark Calabria: No, absolutely.
Mark Zandi: Have you thought about what's going on with the inflation, the growth in the cost of housing services? If you look at last month's inflation report, CPI report, there was a large increase, outsized increase in owner's equivalent rent. That's the cost of homeownership.
Mark Calabria: I've long been of the view that the Fed should respond more quickly because the housing generally enters with a lag, and the Fed is almost always responding to a housing. And as you remember, we had these debates, every 15 years, we debate whether the Fed should care about asset prices. And I can remember the Greenspan response was always, "Well, if this is a real concern, it'll eventually show up in CPI and spending." But the problem is that lag ends up, in my opinion, meaning that the Fed responds to housing at the wrong time. And so I would've had the Fed respond quicker. To be frank about it, the Fed should have stopped buying MBS by the fall of 2020.
Mark Zandi: Mortgage-
Mark Calabria: We-
Mark Zandi: ... securities. Mortgage backed securities.
Mark Calabria: Yeah, mortgage backed. We were through the disruptions in the MBS market that happened in the spring of 2020, which I talk about in my book. And by the time you get to August, September, to me, there really just wasn't a strong justification for the Fed continuing to juice the mortgage market. That's my view. That obviously was not the view of the Fed. I expressed that view to the Fed. And so I think, again, we would be in a better spot today if the Fed had a more real-time ability to react to housing rather than with the lag that they're currently stuck with.
The tension I have is there are people who seem, whose position seems to be that the Fed should never react to housing, like, "Ignore it on the front end when it's inflating." But, "Oh, it's a lag now, so ignore it now." Well, okay, then just say you think that the Fed should always ignore housing. To me, housing consumption out of housing wealth, these are important transmission vehicles. In fact, I would go as far to say, I think housing is the most important transmission mechanism for monetary policy and it's the one we need to take most seriously.
Mark Zandi: Yeah, no, I would agree with that. Okay. Let's turn back into history and when you were FHFA director, again, the regulator for Fannie and Freddie, and the Federal Home Loan Banks, and we're going to talk about the Federal Home Loan Bank system as well, because that's come under some criticism. And to roll the history books back to the teeth of the pandemic, obviously a lot of turmoil at the time. And you took a kind of unpopular-
Mark Calabria: Very so.
Mark Zandi: ... position on all this. Maybe you can just-
Mark Calabria: Oh, some of it-
Mark Zandi: ... bring it the way-
Mark Calabria: Let's break that out. And the book starts January, 2020, but the thinking behind the book really goes back to, I was staff on Senate Banking Committee in 2008. I had oversight for the mortgage programs. And really, I believe the book is largely nonpartisan. I was at the time very critical of both the Bush and Obama response. And for those who remember the programs like HAMP and HARP, to me, they weren't transparent. I didn't think they were fair to borrowers. Lenders are the taxpayer. And so I spent a lot of time in the 2010s thinking about, "Boy, that stuff didn't work well. If by chance I'm in the position of being responsible for this stuff, what would I do differently?" And hence we did it differently. And I do think that the response to what could have been a housing crisis in 2020 was because we made different policy choices than what was made post 2008.
And so let's take a couple of pieces. First it was how did we deal with borrowers? And very much on the front end, I had these, what I call the paper chase scars of post 2008 where you remember borrowers would have to file, and the paperwork would get lost, and maybe somebody wrote something wrong, the lender, whatever, and it just took forever to get people in programs. And so I immediately looked at this and said, "It's a pandemic. We can't set up a system where it takes five to six months to get somebody in." And we also, and it's a real tragedy that this isn't really being fixed, but our unemployment insurance system in America is kind of a mess.
Mark Zandi: Oh, yeah.
Mark Calabria: Even if you get unemployment, in which only about half of workers tend to, as you know, it still takes you maybe two, three, four months to get it. So part of our thinking was, "How do we build a bridge? How do we help people immediately deal with a liquidity shock so that maybe three months later when they get their unemployment check, they can start paying their mortgage and get out?" So in some sense, and there's still debates today, whether 2008 was the liquidity versus solvency event. I think we had somewhat the benefit in 2020 that it was very going to be, clearly for some households, a liquidity event. And this was, "How do we get you to the other side, whether it's the other side of the pandemic, whether it's you getting your unemployment insurance?" The other thing I think that was crucial-
Mark Zandi: Just to make that clear to the listener, liquidity versus solvency. You're making the point that their incomes are disrupted because they can't go to work.
Mark Calabria: Correct.
Mark Zandi: But it's not like their home value is underwater. Their mortgages-
Mark Calabria: [inaudible 00:35:59] the-
Mark Zandi: ... are worth more than their housing value, which is what was the big difference between the pandemic and the financial crisis.
Mark Calabria: Yeah. Or you also think during the financial crisis where you're a carpenter whose career is suddenly not worth what it was because we're not building housing in the same way, so there could be human capital that has depreciated, if you'll, so there's a number of reasons where this was clearly different. And so we structured it differently. Now, there was a decision, and this is actually something I called the Casey Mulligan effect, after Casey Mulligan at the University of Chicago. And Casey came out with a wonderful, if not extremely dense, difficult book to read, his Redistribution Recession on 2010, where his argument was particularly the mortgage programs had very high rates of implied marginal tax rates." So HARP and HAMP, which were the primary Bush, Obama mortgage programs, they were designed so that you got 31 cents of mortgage relief for every dollar of earnings. And of course, the flip side of that is for every additional dollar you earn, you lose 31 cents.
And so Casey went through and added all the other things like benefit loss, tax loss, and there was actually a significant amount of the population that faced marginal tax rates in terms of lost benefits in excess of a 100. So it's like we sometimes have these public debates about people being lazy when no, if you're losing a significant amount of additional earnings, that's a huge work distance add up. So the relevancy here is A, to be able to facilitate getting people in quickly, we weren't going to means test, and I'm generally a proponent of means testing, but we said, "Okay, we're not going to means test and we're also not going to set eligibility based on earnings. We're going to set it on time." Now, admittedly, part of this was when we still thought 15 days to flatten the curve type world, and scores that turned a little longer than that.
And so it really was, "We're just going to get you in and we're going to take your word." The initial design, I'll remind folks that what we set up was about three weeks before the CARES Act, and the CARES Act made some minor changes, some of which ended up being important. But the original design was we'd get people in and three months later, we would check on them, "Have you gotten your unemployment check? Have you gone back to work?" Of course Cares Act got rid of the come back and check. So we really were trying to design something that was incentive compatible that got people in, in a way, easy to get in but tough. Like, "We expect you to pay back." We also created carrots to get people out. So for instance, normally, pre-pandemic, if you are in a Fannie, Freddie forbearance or any type of mitigation, you have to make 12 on-time, monthly payments to be able to eligible to refinance.
So what we did was first we said, "If you have been in forbearance program, but you paid the whole time," which was about a fifth of the program, a lot of people just took it as an option. We said, "Once you exit the program, you can immediately be eligible to refinance." And then for those who missed a payment, we reduced that 12 months to three. So obviously, given those record low rates in the second half of 2020, this was a really big carrot, you know-
Mark Zandi: Hm.
Mark Calabria: ... when a lot of people took that. I will say one of the really surprising things to me, the rather large percent of people who were literally sending us a check for three, four months missed mortgage payment. So a lot of people got out of that. And I'm proud to say that by the time I left, I think over 90% of the people who had entered Fannie, Freddy forbearance had exited. But let's pivot this to the more controversial, because we were providing an option to-
Mark Zandi: That seems all very reasonable.
Mark Calabria: Exactly.
Mark Zandi: Okay.
Mark Calabria: So that's the setup for the controversy.
Mark Zandi: Got it.
Mark Calabria: And thank you. I appreciate the recognition of that being reasonable. So-
Mark Zandi: And I do think you're reasonable. We disagree on many things, but you are very reasoned. I find our disagreements very reasoned, at least your argument's very reasoned.
Mark Calabria: Yeah, thank you. And I think I largely understand most of the time where we disagree, which again, that's a compliment, because it means you're being transparent, generally, about-
Mark Zandi: No, you're fine.
Mark Calabria: ... your assumptions and your model. And so when in a forbearance, obviously the borrower is not paying. So under our existing mortgage programs, well, first of all, the investor still wants to get paid and generally does get paid. So the responsibility of the mortgage servicer, and for those, not for me, the mortgage servicer is basically the one who collects your check and sends it to the investor. Or if there's a foreclosure or some sort of mitigation, the servicer is the one who touches the borrower, if you will. So the servicers were still obligated to transfer the payments to the investors of the MBS, mortgage backed securities, even though the borrower wasn't paying.
Now, I do want to emphasize, because I think this was a point of misunderstanding at a minimum, the contracts that Fannie and Freddie have with servicers are very explicit that this is supposed to be provided even in times of extreme distress. So it is, "We are paying you to do this even when stuff gets bad, that's part of the contract." And so a number of people do servicing, and in fact, servicers often have the choice of whether Fannie and Freddie take over that responsibility. So the servicer can choose to pick contract A or contract B. Contract A essentially says, "Okay, I, the servicer, am going to make less money now because I'm going to share a little bit with Fannie and Freddie, and they will take over the servicing obligation in the event the borrower doesn't pay." And then contract B, which is more lucrative on the front end, the servicer takes that risk. And again, servicers knowingly make this choice.
So because a lot of the servicers were non-banks with very thin balance sheets, there was a real concern by a number of them that they would become under distress by having to make these payments on behalf of borrowers. There was a movement to have the Federal Reserve create a 13(3) facility to provide short-term liquidity. There were calls to have Fannie and Freddie provide short-term liquidity, and none of that ultimately happened. Now, there were different wrinkles. A, we weren't able to do it for Fannie and Freddie because Fannie and Freddie themselves barely, barely survived. I think this is something that's underappreciated. They really came within a hair's breadth of failing because of the cost of the forbearance, the cost of-
Mark Zandi: Failing in the sense that-
Mark Calabria: ... insolvency.
Mark Zandi: ... the capital they had at the time-
Mark Calabria: Would've been wiped out.
Mark Zandi: ... was being exhausted.
Mark Calabria: Exactly.
Mark Zandi: And they didn't have much capital at the time, because they had only begun to ... You only started building capital. Right.
Mark Calabria: So we made considerable progress in that in April, 2019. I can-
Mark Zandi: And Mark, on that one, though, at the end of the day, they're under government conservatorship. It's not like they would-
Mark Calabria: That does not mean ... You can become insolvent and you can have losses. This isn't-
Mark Zandi: There's no way they would've stopped functioning though, right?
Mark Calabria: Perhaps not, but there is a way that you could have potentially seen creditors take losses. You could have ended a receivership. It's not something I think one should take lightly, but is importantly, FHFA has no statutory responsibility toward non bank servicers. Don't regulate them. And So if you think about, you have a waterfall of responsibilities, and your primary one at FHFA is the safety and soundness of the companies you sacrifice. So I would go as far to say, if you put Fannie and Freddie at greater risk in order to benefit non bank services, you would've been derelict your duty under the statute. So for me, it really just wasn't an option because we didn't have the money to do it, which to me, I think is a compelling reason why the companies ultimately needed to be fixed. So I'll remind you that the FHFA director actually has zero say under whether the Fed creates a 13(3) facility for anybody.
Mark Zandi: Sure.
Mark Calabria: And so I think some of the reason that there was some pressure put on me was that Mnuchin was regularly consulting me and what we were seeing, as was the Fed.
Mark Zandi: Treasury secretary under President Trump at the time.
Mark Calabria: Correct.
Mark Zandi: Yeah.
Mark Calabria: And so we were regularly having conversations with the Fed. Brainard at first, who's currently the NEC director, but was the governor at the Fed who was in charge really of the mortgage issues at the time, I had been on the phone pretty regularly with Brainard. We gave them regular updates, "This is what we're seeing." She made very clear to me that they had a facility at the Fed set up and ready to go for mortgage servicers, and they simply needed the Treasury secretary to give the sign-off.
Now, of course, you have to keep in mind as well that Mnuchin had come out of, he had worked in MBS training at Goldman. He had run a bank, had bought IndyMac. So he had a considerable amount of experience in the mortgage market and considered himself, rightly so, to be well-informed. So needless to say, however, Mnuchin's stance was more, "Well, we're not going to do this, but I don't see the reason to tell anybody we're not going to do this." And I think this is where he and I parted on that, where I felt, I'm more from the school that markets perform better, particularly in periods of stress if policymakers provide more certainty rather than less.
And also, as I call it, and I recognize I'm very much in the minority to take this lesson away from Lehman, but my Lehman Brothers lesson is that if you lead an institution to believe it will be rescued, it will not take the appropriate actions to avoid that. For instance, we know Lehman had at least three different offers to be bought, and every time the response was, "We won't take less per share than what Bear got." And the relevancy here, for instance, is they were two rather large non-bank mortgage servicers who had private equity parents, and I'm actually rather pro-private equity, so this isn't a knock on private equity. But the private equity parents had, in 2019, pulled literally billions out of these platforms. And that's fine. Investors get to take their money out.
But when these private equity investors essentially came to Washington and said, "We'd like you to create a liquidity facility to take care of our platforms." Our response was, "We think you should put some of your money back in." And lo and behold, they did. And those platforms have value today, and I think they only really did because basically I had relayed via Fannie and Freddie, to these private equity investors, "If your platforms fail, we can and will transfer the servicing to somebody else, and therefore the value of your platform is gone." So again, this is capitalism. You take the upside, you take the downside. And they were willing to do it. It might be an unusual case that I suspect they were sitting around the table often saying, "You know what? I think that Calabria is crazy enough to do it, so we better put money back in." And it worked. And it may not work, other people might not have that kind of-
Mark Zandi: Right. The same crazy credentials that you need.
Mark Calabria: Yeah. Well, I encourage you, there's a 20-some year old paper by Rogoff called The Case for Conservative Central Banker, and it's really about, like, "How do you establish a credible reputation to be tough?"
Mark Zandi: Yeah.
Mark Calabria: And I think that's often lacking in Washington, because you are, in a sense, trying to solve a prisoner's dilemma game with the predators.
Mark Zandi: It's interesting, you are saying under statute, your interpretation of the statute, "The FHFA could not compel the GSEs to step in and provide liquidity support to the non-banks." That really was on-
Mark Calabria: It was on the Fed.
Mark Zandi: ... on the Fed, and they needed-
Mark Calabria: Yeah, on Congress, and/or Congress.
Mark Zandi: And they needed buy-in from the Treasury to do it. And they were just waiting. And the real disagreement that you had with the Treasury secretary was over just how to articulate this-
Mark Calabria: [inaudible 00:48:28]-
Mark Zandi: ... to the marketplace. I see. Yeah. Now-
Mark Calabria: Yeah. They needed Treasury to sign off. He was not inclined to sign off. Again, to me, I understand the dynamic. We all have decisions in our life where we feel saying nothing is the path of least resistance. And that was his approach there. But again, I felt that I was willing to take public criticism. One of the fun parts of the book was going back and rereading all the kind and generous things that were said about me in the press at the time. You know, the Financial Times is claiming I'm going to cause a meltdown in the entire-
Mark Zandi: Yeah.
Mark Calabria: ... economy because we didn't do this. And part of the reason to relay that is I very much understand what it's like when you're a policymaker, and 95% of the phone calls you get are, "Throw money at this problem."
Mark Zandi: Right.
Mark Calabria: You get very little input from the other side of like, "Well, maybe we should." And again, I do emphasize our approach is very data-driven. So at the time, in March, 2020, there were 346 non-bank mortgage servicers that Fannie and Freddie did business with. I had their income statements, I had their balance sheets. We immediately jumped on the phone. It's a concentrated industry. We jumped on the phone with the 30 largest. We said, "Look, I've got your financials. What has changed?" And so it really was, "We're going to take a data-driven approach to this. We're going to see where the stress is." Every morning during at least the first six months of the pandemic, I received a servicer watch list. And we were in constant conversation with those who we thought ... We also during these calls were regularly updating. We had a running tally of what we thought servicer transfer capacity was. And we would call people and say, "If we needed to transfer some servicing for someone else, how much can you take?" And we were comparing these circles of, you know-
Mark Zandi: Mm-hmm.
Mark Calabria: ... supply and demand, if you will, and trying to manage that in a way. Certainly that was more work than just creating a liquidity facility and rescuing people. I do think there was a degree of, A, I think the industry felt that everybody else was getting a rescue, and therefore why were they being excluded? And to the credit, one CEO in the mortgage industry said to me on a phone call, he's like, "Mark, we were just hoping you would be a voice for the industry." And I said to him, "I'm an arms length independent regulator. You have lobbyists you pay. That's their job." And-
Mark Zandi: I'm guessing at the end of the day, though, just to push back, and-
Mark Calabria: Sure.
Mark Zandi: ... not even a pushback, just an observation, that there was so much support provided to the economy that ultimately supported the housing market. All the checks that were cut, all the other support, you don't have to pay your credit-
Mark Calabria: So-
Mark Zandi: ... card bill and stuff with the-
Mark Calabria: So if I can preempt to where I think you're going with this?
Mark Zandi: Okay.
Mark Calabria: Because I know you and I had very different public estimates of forbearance.
Mark Zandi: Right.
Mark Calabria: And this actually ended up being a lucky coincidence. I had hired Lynn Fisher, who I think you know, and we had stood up our, I'll say as a shocker, when I walked into FHFA, there was no housing market, housing price forecast function. They completely relied on whatever Fannie and Freddie told them. And again, the primary risk to Fannie, Freddie, and the federal banks is fundamentally macroeconomic and housing market. They did none of that. There was no separate research division. So we set that up. We opened the doors to our new research division January 1, on 2020. And where I'm going with this is we went and back forecast, like, "What do we think forbearances will get up to based on unemployment?"
And we forget, I know there's a narrative, and I'll be frank, I strongly disagree with this narrative that somehow we didn't do much or do anything post 2008. My view is we spent a lot. We spent it poorly, we sprayed lots of disincentives, we expanded unemployment insurance. So the point being is that the argument of, "We got our estimates right by luck because a lot of assistance was provided." The response for me is that those estimates were based on the assumption of lots of assistance being provided because they were a historic backcast on periods in which lots of assistance was provided. I do recognize we did provide more assistance this time around.
Mark Zandi: A lot more.
Mark Calabria: A lot more.
Mark Zandi: I mean orders of magnitude more, like 25% of GDP more. That's a lot more.
Mark Calabria: Exactly.
Mark Zandi: Yeah.
Mark Calabria: So I would say it's certainly a tough empirical question. I think it's probably fair to say our internal numbers, we really ... First, I'll phrase it this way. I was asked third week of March, 2020 by Diane Olick, "How bad do you think this is going to get?" And I said, "By middle of May, I think Fannie and Freddie- "
Mark Zandi: CNBC, by the way, she's the-
Mark Calabria: And I-
Mark Zandi: ... housing person on CNBC.
Mark Calabria: And even though, and I'm sure you've experienced this, my econ team was probably having heartburn. They were probably saying to themselves, "Don't give an answer." But I gave a date and a number and I said, "I think by middle of May, were probably going to peak around 6% for the Fannie and Freddie book. And of course, FHA and other parts are much worse." And the Fannie and Freddie book did actually peak middle of May at about 6.7. So, not far off, but that was our median estimate. And we really looked at this and said, "Our 90% confidence interval is maybe 15%, tops." And so for us, we were prepared to act if it got worse. We really weren't seeing things that would suggest that it would get to 30, 40. But again, we were clear the whole time, "If it gets worse, we will change the stance."
But we did a lot of data analysis on this. I do want to emphasize, I think there's a sense of people just thinking, "Calabria's an idealogue. He's just pulling numbers out of hats." No, there was a lot of analysis put into this. We looked at the range of outcomes, we looked at historical experience. And I would say at the end of the day, I think the programs that we enacted, if you try to figure out a way to split this, I'd probably say maybe 40, 50% was driven by the extraordinary assistance given relative to other crises, and that the rest of it was within historical norms.
Mark Zandi: Well, I highly recommend the book. I really enjoyed it. I think you actually took a couple of my quotes in there, somewhere-
Mark Calabria: I did.
Mark Zandi: ... as I recall.
Mark Calabria: I hope you-
Mark Zandi: Yeah. There's-
Mark Calabria: ... feel it was fairly-
Mark Zandi: Oh, yeah, no.
Mark Calabria: ... fairly represented.
Mark Zandi: Obviously a lot to debate, there, but because we're running out of time, I promised we keep this to an hour, and let's roll. We took a historical perspective. Let's look forward now, and there's two things I want to quickly bring up. One is around going back to the non-bank mortgage industry, the folks that you had a lot of pressure to bail out, there's still the dominant force in the mortgage finance space. There are 80, 85% of the loans made by Fannie, and Freddie, and FHA. I want to get you a quick sense of the risks there. I mean, there's a lot of concern, still concern, as you said, they have pretty thin balance sheets, as you said, very low capital. Is that something that we should be worried about going forward?
Mark Calabria: Is something we should be worried about. And I'll say, from what I saw, counterparty risk management via the Fannie and Freddie lens. A lot of these non-banks are bundle of contracts relying on outside vendors and subservicers. And I'm not knocking on them. It's not something that should give you a tremendous amount of comfort. But that said, I will say I think we've got the abilities to deal with, we were lucky that we didn't have a number of them fail. And as I mentioned in the book, we dealt with, Ditech failed in the fall of 2019. We had just come through dealing with a large servicer failure. And Fannie and Freddie have dealt with servicer failures in the past. So this wasn't something that was untried.
The question was would it be en masse? And that's the difference is looking at the balance sheets, they were maybe at half a dozen riding the line, and again, riding the line, there was never any evidence that you would have dozens go down. And that's a different animal. And so I think that's the question. I think, A, the system can handle the failure of one, two, three large non-bank servicers. Can the system handle the failure of 20? You know?
Mark Zandi: Mm-hmm.
Mark Calabria: And that's a separate set of questions. And of course there have been counterparty standards that have been put in place. I know you and others have suggested, perhaps, giving them access to the Federal Home Loan Banks. One of the starting points that I come from is that, and again, I'm not anti non-bank, I think it's been often misinterpreted by the industry. We had started a working group among regulators in late 2019 that unfortunately, the pandemic kind of swamped, where basically mortgage bank reform working group, and because you can't just fix this in the Fannie and Freddie Freddie's side, there are a myriad of reasons that depositories have left the mortgage business.
Of course, though, it's important to keep mind, depositories do as much servicing as the non-banks. And of course, they're not facing liquidity pressures either because they have access to Federal Home Loan Bank advances or the discount window. And of course, as COVID started going, they had record inflows and deposits. And my approach is, rather than throwing our hands up and saying, "Well, we're never going to get depositories back in the mortgage market in a big way," I think we really need to address the problems that have driven depositories out of the mortgage market. I don't think that's healthy. So rather than just expand the safety net, I'd rather look at issues that-
Mark Zandi: [inaudible 00:58:58]-
Mark Calabria: ... are-
Mark Zandi: ... their share, get the banks back in lending.
Mark Calabria: Yeah. And again, because at the end of the day, we actually haven't driven the banks out because, as you recall, almost all of these non-banks function with warehouse lines of credits for these very safe depositories.
Mark Zandi: Yeah, exactly.
Mark Calabria: So we've created this complexity. Now, I do want to, for the listeners, give a plug. You, and Jim, and a couple of your colleagues, Jim Parrott, have written two wonderful papers on the federal bank system, that is much I agree with. The part I disagree with, expanding the footprint, but I want to emphasize a couple of points because I think-
Mark Zandi: In that case, just to make it clear, under certain conditions. Right?
Mark Calabria: Exactly.
Mark Zandi: Big conditions. Yeah.
Mark Calabria: Absolutely.
Mark Zandi: Yeah.
Mark Calabria: So there's a couple and these papers are both published by the Urban Institute and people can find them on the website there. A, one of the critically important points that you make in that paper that I fully agree with is that the purpose of the Federal Home Loan Bank system is to be a provider of liquidity in a stress environment. And a point I make in the book is that's exactly what they did in March, 2020. You saw advances increase by 30% before the Fed or the Treasury did anything. So it's a much quicker advance network. The federal home banks worked as they were supposed to work in COVID, and they did it correctly. And coming from me, that should mean a lot because I'm not one to applaud-
Mark Zandi: It does.
Mark Calabria: ... end up using regulate.
Mark Zandi: It means an awful lot. Yeah. Even Cris doesn't agree with that. So-
Mark Calabria: So-
Mark Zandi: That's great.
Mark Calabria: The part of the debate, I think, that's missed here is somehow the debate has raised these questions about, "Well why are they doing this lender of last resort?" And I'm like, "The Federal Home Loan Bank system was created to be a lender of last resort, of course, to thrifts who could not access the Federal Reserve system. And that's no longer the case." So on one hand, the original purpose of the Federal Home Loan Bank system is no longer with us, but the statutory design, and during my tenure, I repeatedly said to the banks, I was like, "Your primary existence is because you're going to, supposed to provide liquidity in times of stress. Don't do anything to screw that up." That's repeatedly what they heard from me. And so I am puzzled by the conversation that's moved toward, "Well, they're not supposed to be lenders of last resort. I think this is primary being driven by the Fed." But yeah, the statutory history, the statutory language all says, "Actually that's why they were created."
Mark Zandi: We are so in agreement here. That is so cool.
Mark Calabria: So the other thing that I think that I really love that you guys did, because I've said this repeatedly, so it was nice to see some math, here. People have pointed to Silvergate and SVB, you know, and it's this-
Mark Zandi: Hm.
Mark Calabria: ... case of, well, I can say survivorship bias, but perhaps it's non survivorship bias that's really ... People aren't asking the question of, "What about the depositories that don't fail because they got advances?" And I really like the fact that, and I've said that repeatedly to people, and I like the fact that you guys put that in, you put some numerics behind it, you put a logit regression behind it. But the parse that out that I think is important where I would take the reform-
Mark Zandi: I don't know if you noticed that Cris is smiling over here. I don't know.
Mark Calabria: So work? I enjoy, I haven't run a logit in over a decade.
Mark Zandi: Yeah, right.
Mark Calabria: I like the way the paper was done partly because it did confirm-
Mark Zandi: Thank you.
Mark Calabria: ... my priors, which is always-
Mark Zandi: That's always helpful.
Mark Calabria: And so there are a couple elements of the paper that I thought were also important to me, A, that what really matters for banks is the increase in liquidity in terms of stress, because that reduced the chance of failure. But on the other hand, banks that relied on Federal Home Loan Bank advances essentially is day-to-day liquidity management, had higher chances of failure.
Mark Zandi: Right.
Mark Calabria: And again, reinforces my point that the banks, in fact all the GSEs, Fannie, and Freddie, the Federal Home Loan Banks really are created to be countercyclical. And the problem with them is over time they've become more pro-cyclical. So the conversation really should be, "How do we get these entities to be more countercyclical?" And then the other point I think is important that I take away from that paper is that the liquidity for a stress environment is really important for the small institutions and not as much for the big institutions.
I'm aware of the debates about Wells and Chase pay the overhead, but to me, I think it's a reasonable part of the conversation of how concentrated the advances are among the Wells and Chases, whether that's really an appropriate outcome for the system. So I would quite frankly, probably anybody over 10 billion, I would probably throw out of the membership, it was up to me, again, it's up to Congress, and really have it focus on small institutions. And then I don't want to open up a whole debate, but just as a reminder, the implied guarantee is not something that Congress ever intended or gave to the banks. It's something that market expectations have created. And I worry that part of the conversation about the Federal Home Loan Banks takes this view of, "Here's this subsidy, how do we distribute it more equitably?" When the fact is that was never at a subsidy that was intended. Of course, the tax relief and other things are intended and provide subsidies.
And so rather than increasing the affordable housing contribution, honestly I would get rid of it altogether and I would subject the banks to the corporate tax code, and they pay into the general fisc like everybody else, because I'm not really a fan of earmarked, off-budget spending. But fundamentally, my worry is that the conversation takes the implied guarantee as something to be spent. And quite frankly, if you think about it, the value of the implied guarantee is a function of the probability of failure, because the implied guarantee only has value to debt holders if there's a failure.
And so to some extent, the larger the implied guarantee is, by almost definition, the worst job the regulator must be doing. Because your job as the regulator is to try to minimize the outcome of failure. So I was a little disappointed that the conversation doesn't really focus on, "How do you reduce the probability of distress in the system, which therefore reduces the implied guarantee?"
And lastly, I want to say since I know we're going over on time, as you recall, I worked on the statute that created FHFA. Congress very clearly intended, both with Fannie, and Freddie, and the Federal Home Loan Banks, to minimize, if not try to reduce the implied guarantee. And I feel like the debate's gone the wrong direction on that. But I really do recommend, those two papers I think are very well done and raise important questions, even if there's some areas I disagree with. I think they raise some core questions that I don't see being raised necessarily by others in the debate.
Mark Zandi: Well, I want to thank you. I want to say two things. One, thank you for that. That was very kind of you. I came prepared to have a big debate about the Better Home Loan Bank, so that, you completely took me off guard, there.
Mark Calabria: Well-
Mark Zandi: I didn't know what your views on that were, but I was expecting that you had a different perspective. But that could be-
Mark Calabria: Maybe to confirm your priors, if we didn't have the Federal Home Loan Banks today, I wouldn't create them, but we do.
Mark Zandi: Okay.
Mark Calabria: So how do I deal with the current mess?
Mark Zandi: And that's fair. That's fair. I have this metaphor in my mind that the liquidity system in the financial system is basically this complex Rubik cube of plumbing, pipes going everywhere. If you try to pull the pipes out at this point, you're just going to create a real mess.
Mark Calabria: That's why to me, I think you trim the system, like Wells and Chase are going to be fine if you kick them out of the system. And-
Mark Zandi: Well-
Mark Calabria: I do think, while my first, best preference is, I guess I'll put it this way as a reminder, a third of banks have disappeared since Dodd-Frank. Of course some of it's merger and there were trends and declining. And it gets back to the earlier part of our conversation, one of the real problems in the housing sector today is the difficulty of getting acquisition development, construction lending. And I'm not knocking on the big guys, but this is primarily a function of community banks, regional banks. And I really worry that the consolidation and the disappearance of many community institutions in America has reduced the availability of construction development lending.
And so to me, the rationale for the system, it's really a second-best argument, if you will. You're trying to use the liquidity provision of the system to offset what I think have been policy changes that have made it much more difficult for community banks to survive. But you can trim the system by eventually getting rid of the big guys and being focused on community institutions. Yes, that would probably push some consolidation among the Federal Home Loan Banks so that they could cover the overhead better. But there's really not. This question came up I think on my first day from some of the bank presidents. "Well, what do you think about consolidation?" I'm like, "I got 10 other problems that are bigger to deal with. I got 1,000 to one leverage Fannie and Freddie. You guys want to merge, I will be your partner and help facilitate it. If one of you fails, there's certainly going to be a merger."
But at the end of the day, I raised that to say, "Eleven's certainly not the right number. The system is too fragmented for efficiency." I think it's a really hard political battle for the regulator, because obviously whatever city loses you're going to hear from their senator. So it's not an efficient system the way the geographic layout is today, I think that's ripe for reform. But I also think it might not be worth the political trouble you have to go through. We didn't even get into the fact that half of my conversations by minutes with the board's management were about their executive compensation. And so there are problematic practices at the bank. There are safety and soundness concerns, but the point about these are functionally supposed to be providers of liquidity to community institutions in times of stress, is 100% right. And that's really where most of the debate should be.
Mark Zandi: Well, given that, all what you just said, we have the fodder for the next time we have you on the podcast, because there are a few things I'd like to pick you up on, but we need to call it a podcast. I will say we were really deep into the weeds, here, so some of the listeners probably may have had some difficulty following along, particularly on the Federal Home Loan Banks, but I would say you might want to go back and listen to the podcast we did with Teresa Bazemore. Teresa is the president of, I think the president's the right word, for the-
Mark Calabria: Or of course the listeners can read the papers you've done.
Mark Zandi: Yeah, exactly.
Mark Calabria: They're very accessible. And of course they could read my book. So it's all-
Mark Zandi: Yeah, there you go. All there, all there for you. And of course, if you have questions you can fire away, too, listener, we're all ears. Would love to have the questions. Mark, I want to thank you, really, very informative and as I said, you really lay out a very cogent, reasonable case and I really appreciate your clarity and transparency. And with that, we are going to call this a podcast, dear listener. Talk to you next week. Take care, now.