The Impact of Secondary Mortgage Market and GSE Purchases on Underserved Neighborhood Housing Markets: A Cleveland Case Study

Since 1992 the federal government has established regulations encouraging the Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac to purchase home mortgages originated in neighborhoods traditionally underserved by financial institutions, with the aim of stimulating housing market activity there. This research tests this proposition empirically, based on an econometric analysis of single-family home sales volumes and prices in underserved census tracts in Cleveland, OH during the 1993-1999 period. Our analysis reveals a positive relationship between home transaction activity and the actions of the secondary mortgage market. Based on our robustness tests, we are most confident in concluding that secondary mortgage market (and the non-GSE sector in particular) purchases of mortgages have a positive effect on the number of sales transactions one year later. We observe no consistent impact of purchasing rates on sales prices, although non-GSE purchases of non-home purchase mortgages appear to boost prices one and two years later. There is no robust evidence however, that GSE purchasing rates are positively associated with single-family home transactions volumes or sales prices during any periods. Impact of Secondary Market and GSEs on Underserved Neighborhoods, January, 2003 3 The Impact of Secondary Mortgage Market and GSE Purchases on Underserved Neighborhood Housing Markets: A Cleveland Case Study Lance Freeman and George Galster, Co-Principal Investigators Introduction Credit is the lifeblood of neighborhoods, providing the resources to upgrade and prosper, or, in its absence, decline and decay. That credit is important to the health of neighborhoods has long been recognized among students of neighborhood change. It was not until the late 1960s and early 1970s, however, that policy makers began taking steps to insure that credit was accessible to all without regard to race or geographic location. Prodded by community activists who saw a lack of access to credit as a major cause of decline in their neighborhoods, policymakers have enacted a series of policies designed to increase the flow of credit into low income and minority communities. These include the Equal Credit Opportunity Act of 1974, which forbade racial or ethnic discrimination in any aspect of a credit transaction, the Home Mortgage Disclosure Act of 1975 and subsequent amendments, which required lenders to provide demographic data on their loans, and the Community Reinvestment Act of 1977, which obligated lenders to meet the needs of low and moderate income neighbors (Yinger 1995). With the reorganization of the financial services industry during the 1980s, the secondary mortgage market came to play an increasingly important role in the allocation of housing credit through the increasing volume of mortgages they purchased and by raising capital by issuing mortgage backed securities (Macdonald, 1996). Indeed, many primary market financial institutions have essentially become mortgage processors who originate and service mortgages, while the secondary mortgage market assumes the risk. As a result, the underwriting standards of the secondary market have become increasingly important determinants of access to credit in all communities, but especially in low income and minority communities. “If we can’t sell it, we can’t make it” has become the guiding principle of many primary market mortgage lenders (U.S. Congress, Senate 1991, 114). Cognizant of the role the secondary market plays in determining access to credit, the policies of the Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac have come under increased scrutiny as possible obstacles to increasing credit for low income and minority communities (Temkin, Quercia, Galster, and O’Leary, 1998). The GSEs’ quasi-governmental status makes them a natural focus of government policy aimed at influencing the impact of the secondary mortgage market on low-income and minority neighborhoods. Moreover, the substantial benefits that the GSEs receive from the federal government creates an obligation on their part to serve the public interest. Increasingly, this public interest has come to include making credit more accessible to low income and minority communities. The increasing focus on the GSEs making credit accessible to low income and minority communities culminated in the Federal Housing Enterprises Financial Safety and Soundness Act (FHEFSSA) of 1992. The FHEFSSA granted the HUD Secretary authority to establish and enforce goals for GSE purchases of mortgages on homes purchased by lowand moderate-income households, housing located in central cities, rural areas, and other “underserved areas,” and “special affordable housing” meeting the needs of families earning less than 60% of the area median income. Interim purchasing Impact of Secondary Market and GSEs on Underserved Neighborhoods, January, 2003 4 goals were established for 1993 and 1994, with final rules written in the fall of 1995 (U.S. Dept. of Housing and Urban Development, 1995). Implicit in all of the policies designed to increase credit to low income and minority neighborhoods is the notion that not only is this the equitable thing to do, but the end result will be healthier neighborhoods and less urban decline. Although this appears to be a reasonable assumption, until now it was untested. As the literature review in the next section makes clear, there is scant empirical evidence on the nature of the relationship between the secondary mortgage market components-the GSEs (Fannie Mae and Freddie Mac) or and other non-GSE institutions-and housing market activity in disadvantaged neighborhoods. The research reported here attempts to fill this gap by developing a theoretical framework for viewing the relationship between housing market conditions in underserved neighborhoods and the secondary mortgage market and empirically testing this relationship. Given the focus of the policy reforms on underserved groups (both households and areas) we focus our attention on underserved neighborhoods. For this study we rely on the federal definition of an “underserved” metropolitan neighborhood: a census tract with median family incomes less than or equal to 90 percent of the area median income, or tracts having 30 percent or more non-white population with median family income less than or equal to 120 percent of the area median income ( Code of Federal Regulations [Title 24, Volume 1] [Revised as of April 1, 2001] From the U.S. Government Printing Office via GPO Access [CITE: 24CFR81]). The GSEs and Underserved Neighborhoods With one notable exception (Thibodeaux and Ambrose 2002), the literature on the secondary mortgage market in general and GSEs has focused on how well the GSEs are meeting the goals set forth under the FHEFSSA, and how the GSEs compare to other secondary market players and primary market institutions in terms of serving underserved neighborhoods and populations. The literature has consistently found that the GSEs mortgage purchases to underserved neighborhoods and populations have been increasing, and are meeting the FHEFSSA targets (Bunce 2002; Manchester 2002; McClure 1999; Neal and Bunce 1998; Williams 1999; RFGA, p. 24.; Department of Housing and Urban Development, 2000). A general consensus also appears to be emerging from the second strand of GSE-related research that looks at how well the GSE’s efforts to serve underserved markets compares to other actors in the secondary mortgage market. The findings from this body of literature have typically found the GSEs to trail behind the rest of the secondary market in terms of serving the underserved markets (Bunce 2002; Bunce and Scheessele 1996; Freddie Mac 1998; Lind 1996; Manchester 1998; Manchester, Neal and Bunce 1998; McClure 1999; Williams 1999; Van Order 1996). Canner and Passmore (1995) and Canner, Passmore, and Surette’s (1996) found depository institutions to serve FHA-eligible borrowers to a larger degree than either Fannie Mae or Freddie Mac. The authors suggest this is because of the GSEs’ lack of knowledge about local neighborhoods, especially when compared to depository institutions. Two recent qualitative studies based on the opinions and perceptions of knowledgeable informants in the home lending industry echo Canner et al.’s speculation on the causes of GSE’s “lagging” performance and sheds some light on why the GSEs tend to “follow” the market when it comes to serving underserved areas (Temkin et al. 1998, 2001; Fosberg (2001). As a result, the GSEs have minimal opportunity to underwrite mortgages without using formulaic guidelines. The literature thus paints a picture of the GSEs increasing their purchases from underserved areas in both absolute and relative terms. Although the consensus Impact of Secondary Market and GSEs on Underserved Neighborhoods, January, 2003 5 emanating from the literature is that the GSEs do not serve underserved markets as well as other financial institutions in the primary or secondary sectors, the gap between them and the rest of the industry in serving underserved markets is narrowing (Manchester, Neal and Bunce 1998; McClure 1999; Williams 1999). What remains less clear, however, is what impacts, if any, are the GSEs’ targeting efforts having on the revitalization and or upgrading of underserved neighborhoods. To our knowledge, only one study has attempted some answers. Thibodeaux and Ambrose (2002) found that borrowing costs were lower in MSAs where GSEs purchased a higher proportion of conventional loans, and overall mortgage lending volumes were higher when GSEs purchased more seasoned loans that had been held some years in primary lenders’ portfolios. Moreover, they found that the gap in ownership rates between lowand high-income households dropped in MSAs where GSEs expanded their purchases more strongly, though in the national sample they appeared to have no impact on the growth of low-income homeowners