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The affordable housing paradox and complex credit policy decisions

Updated: May 26, 2022

The complexity of credit box expansion and why a supply-side policy is important.

Recently, there has been momentum toward the expansion of the "credit box." Think of the credit box as credit policies that guide mortgage lending; like loan limits, FICO score cutoffs, LTV thresholds, and debt-to-income requirements. If building a mortgage is like building a car, credit policies are like the quality control standards found on a car factory assembly line. Expanding the credit box causes an increase in housing-related demand. This article explores credit box expansion complexities and the paradox that expanding the credit box creates an environment counterproductive to affordable housing. We provide several sustainable affordable housing policy examples. We recognize credit box expansion may be unavoidable and there are many alternatives. We provide complex credit policy decision solution ideas.


Credit Box expansion impact

In April 2022, as reported by and others, rents across the U.S. are increasing substantially. Simultaneously, the volumes on Single-Family Rental (SFR) bonds are the highest in decades. Powerful investment firms have entered the SFR bond market-making business. In some cases, investment firms participate with their own SFR supply. This will likely cause an increase in calls for rent control. This article explores why rent control is contrary to affordable housing. In February 2022, as reported in the financial press, interest rates are increasing quickly. Long-term, market set rates are up significantly and in anticipation of the Federal Reserve's short-term target rate increases. As suggested by economist Bill Knudson, this will have a significant impact on home affordability. It is expected policymakers will be under pressure to “do something” and expand the credit box. This article explores why this sort of demand-side policy action pulls against affordable housing.

In November 2021, as reported by the Wall Street Journal, Fannie and Freddie's (the "GSEs") loan limits increased significantly. Not long after, in January 2022 and as reported in Housing Wire, the GSEs increased fees for higher balance loans. Does it make sense for the GSE's to chase home values that increased, in part, as a result of the accommodative, pandemic-based monetary policy? While fees have increased at the margin, the impact of the loan limits should greatly exceed any demand tamping associated with marginally higher rates. Particularly notable is the size of the loan limit increases.

In June 2021, as reported in a Marketwatch article, the Supreme Court decision could help advance Biden’s housing agenda — starting with the firing of the FHFA director. Some interpret this as increased political pressure to expand the mortgage credit box. This article explores why credit box expansion is contrary to affordable housing.

In late 2020, the CFPB announced the relaxing of the Qualified Mortgage Debt To Income rule. This rule required at least 43% of a borrower's income to be available to service their mortgage debt. The relaxation provides lenders more flexibility to assess the ability to repay. This should increase the availability of credit, especially to those on the margin from an income capacity standpoint. This article explores why increased credit availability is contrary to affordable housing.

One of the great lessons of and contributors to the Financial Crisis & Great Recession was expanding the credit box. Driving higher homeownership rates with demand side credit standards is like playing with fire.

The credit box expansion complexity involves home prices and participating agent incentives. From an economist’s standpoint - these sorts of policy changes, relaxing credit standards, shift the housing demand curve to the right. This shift has the effect of maximum upward leverage on short-run housing prices, especially given the housing stock is generally fixed in the short run. Paradoxically, expanding the credit box causes housing to become less affordable. Please see the following economic framework:

Economists are trained to follow the organizational incentives as a way to understand the participating agent’s motivation. (i) A quick incentive review suggests, those who need affordable housing the most may least benefit from expanded credit.

Who benefits from an expanded credit box? - an agent’s incentive review:

From a lender’s standpoint -> good news, more demand for loans, revenue goes up.

From a realtor’s standpoint -> good news, more demand for houses, revenue goes up.

From the housing manufacturer's standpoint -> good news, more demand for houses, revenue goes up.

From the politician's standpoint -> good news, expanding the credit box and increasing the homeownership rate is a positive narrative during the typical 2 to 6-year election window.

From the property investor’s standpoint -> good news, increasing property prices equate to more properties that meet or exceed property cash flow and return thresholds.

From the mortgage investor's standpoint -> mixed news, more mortgage volume creates more short-term revenue, but a lack of affordable housing and an increase in associated embedded credit (collateral) risk may sow the seeds for a major housing market correction. There are such powerful lessons from the last financial crisis. (ii)

For those mortgage borrowers at the margin -> mixed news (at best) and trending bad, even though more credit will be available, upward pressure on housing prices will cause housing to become less affordable. This greatly reduces the benefit of credit availability and creates risk for those needing affordable housing.

There are some nuances to particular housing demand policy changes. Higher demand alone may not motivate home builders to build more affordable homes. Also, it is yet to be seen if a particular policy change, incrementally, will move the needle on housing prices. The point is that the cumulative effect of a relaxed housing demand policy increases housing price pressure in the short run until market supply equalizes in the long run.

Who has the power to influence affordable housing? - A ”Power Pie” review:

This may leave you thinking: “This is pretty straightforward, it seems like we have a clear path to solving affordable housing challenges!” While the housing economics are relatively straightforward, getting housing constituent “ducks in a row” is another story.

As the Power Pie graphic shows, there are a few powerful lobbying or government groups watching after their constituent’s interests, like realtors, home builders, lenders, and mortgage investors. In general, affordable housing interests are watched after by well-meaning but lower-powered advocacy groups.

As noted earlier, demand-side stimulus often causes less affordable housing. As the incentive review reveals, higher-powered interests economically benefit from demand-side stimulus. This is not to suggest the more powerful interests do not care about affordable housing. They absolutely do! However, they must balance affordable housing in the complex context of their constituent’s broader interests.

It is no wonder why it is challenging to maintain a consistent and effective affordable housing policy. Demand policy change dynamics are very complex.


Policy implications

Like a dog chasing his tail, housing demand policy expansion (like loan limits) enables a self-reinforcing housing price inflation cycle, where the long-run housing supply is challenged to equalize. This is ground-zero for our affordable housing crisis.

As such, generally, stable demand-side and active supply-side focused housing policies are necessary to create sustainable affordable housing:

  1. A stable and consistent housing demand policy. Demand standards, as related to mortgage credit policy, are influenced by regulators such as the CFPB and FHFA. Mortgage credit policy is set by Investors like the GSEs / FHA / GNMA, and banks. I am not taking a position on the particular credit policy. In a perfect world, the idea is that mortgage credit policy remains stable and is a stranger to use as a short-term policy tool. [Set it and forget it (iii)]

  2. Active supply-side housing policy focus. That is, focus on the appropriate housing stock supply policy. Examples include:

    • Updating local zoning and related “NIMBY” friction to housing development. (iv)

    • Aligning tax policy between the local housing impact of employees with the tax burden to their employers. (v)

    • Reducing local rent control and related market distortions. (vi)

    • Providing tax incentives and immigration vouchers to incentivize builders to build affordable homes. (vii)

The good news is that many of these supply-side examples have positive momentum. We discuss recent examples in the notes section.

Back to housing demand policy and mortgage credit policy, while the perfect world may be geared toward a "set it and forget it" policy approach, in the real world, investors do not generally have that luxury. Investors live in the complex world of multiple complex criteria decisions based on:

  • the participating agent incentives (as earlier outlined),

  • investor revenue needs, and

  • investor longer-term risks.

Also, investors need to evaluate the criteria by overlaying different mortgage credit policy scenarios. Making these complex decisions is not easy, it requires a disciplined and intentional process involving:

  • objective information (e.g., market housing prices, revenue requirements, financial risks),

  • judgemental information (e.g., multiple agent input, non-financial risk consideration, senior leader input),

  • a process that engages all stakeholders and provides decision science-enabled technology support.

  • a dynamic process enabling policy changes as markets change.

In the notes, we provide an exemplar technology solution for assisting with complex mortgage credit policy scenario decisions. (viii)



In a locally constrained housing market and if demand is artificially spurred by accommodative credit policy, housing values have nowhere to go but up. The winners in a fast-moving housing market are typically the first movers. These are likely to be property investors and other more sophisticated demand-brokering participants. (ix) A longer-term supply-side housing policy focus is needed if the goal includes affordable housing and appropriate homeownership levels. (x) This aligns with the reality that it takes time for housing markets to respond to demand changes. The long-term health of the mortgage finance industry is aligned with appropriate supply-side housing policy. From a practical standpoint, investors do need to periodically change demand-side/mortgage credit policy. This is best done with a disciplined process and decision science-enabled process and technology.

Ultimately, order of operations matters. Spurring demand in a hot housing market is like using gasoline to put out a fire. Best to focus on supply-side housing policy and a disciplined mortgage credit policy change process. This will provide for the health of the industry and for long-term, sustainable affordable housing.


(i) Incentive misalignment may cause additional risk concerns, known as the agency dilemma:

Agency problems may be manifest via demand-side policy expansion. In the case of a mortgage lender, if they kept loans in their own portfolio then their incentives should be aligned. Since the agent and principal are the same, this results in little agency impact. However, the majority of mortgage loans are sold into GSE guaranteed securitization structures. In this case, the incentives may become misaligned because the mortgage lender/seller (the agent) does not hold the credit risk. Thus the mortgage investor/buyer (the principal) may be taking risks born from agency misalignment. The agency dilemma was a core driver of the mortgage crisis that started in 2007. As an example, please see this quote from a mortgage crisis legal settlement brief:

"{A Big Bank} employees even referred to some loans they securitized as 'bad loans,' 'complete crap' and ‘[u]tter complete garbage.’"

(ii) So let's dig into credit (collateral) risk a bit. Higher collateral values, narrowly defined, are a good thing for credit risk. Higher collateral value lowers the LTV and reduces credit risk. The problematic side to the higher collateral value issue is housing value volatility. One of the pillars of the U.S. Mortgage Finance system is the assumption of home value stability. Home values, like most asset prices, are mean-reverting. If housing values persist at higher than average growth rates, by statistical definition, they will correct. It is not a matter of "whether," it is a matter of "when." As we saw in the great recession, large corrections can be unexpected, may occur quickly, create a momentum of their own, and create significant, hard to reverse economic damage. In particular, people that are marginal credits and are in need of affordable housing, tend to be especially sensitive to a correction cycle, creating more significant credit damage for both people and investor portfolios.

(iii) "Set it and forget it" credit policy. The idea is, for GSE and government-based mortgage market makers and insurers, credit policies are based on long-term, multi-economic cycle modeled drivers, like prepayment speeds and especially for credit loss assumptions. In the context of credit loss, using long term loss assumptions will:

  1. Reduce the change frequency of loss assumption and related credit policy, guarantee-fee, or loss-related pricing.

  2. Act as a countercyclical "planned inertia" demand policy tool.

    1. In "hot," low loss, high demand markets, long-term credit and pricing assumptions will be higher than those in the short-term "hot" market. This has the effect of reducing demand toward the mean and for the investor to accumulate excess loss reserves.

    2. In "cold," high loss, low demand markets, long-term credit and pricing assumptions will be lower than those in the short-term "cold" market. This has the effect of increasing demand toward the mean and for the investor to release accumulated loss reserves.

(iv) There has been recent state and local government movement toward banning or reducing local single-family zoning. California signed SB9 into law, effective January 1, 2022. This follows Minneapolis and Oregon in 2019. California is generally the poster child for affordable housing challenges and a general lack of housing supply. In 2021, California has 12% of America’s population but hosts 28% of its homeless.

[See: The Economist, California ends single-family zoning, 2021]

SB9 will make it easier to build apartments and convert existing single-family homes to 4 unit multi-family homes. Also, there is a provision requiring owner-occupancy, so the immediate benefit to property investors may be muted.

(v) Amazon announced an Affordable Housing program.

"The bulk of its investment will be through low-cost loans to preserve or build affordable housing, Amazon said. The company also will offer grants to public agencies and minority-led housing organizations."

(vi) Diamond, What does economic evidence tell us about the effects of rent control?, Brookings Institute, 2018. “While rent control appears to help current tenants in the short run, in the long run, it decreases affordability, fuels gentrification, and creates negative spillovers on the surrounding neighborhood.”

(vii) Jeffrey Hulett, America's Mega Forces - Making the most in a time of change. The Curiosity Vine, 2021. We introduce the “The Community Invitation program” as a related economic mechanism to provide affordable home building incentives.

Unfortunately, the inelastic “stickiness” of home building supply seems to be increasing. In an analysis by The Economist, builders (supply) are on a long-term downward trend.

(viii) Definitive Business Solutions provides an exemplar technology solution. Please see this white paper for more information: Effectively Using Decision Support Solutions.

(ix) Property investors and more sophisticated demand participants will siphon consumer surplus related to a housing transaction. Supply-side policy to normalize housing stock may provide more consumer surplus to the borrow/homeowner and reduce the consumer surplus available to property investors.

(x) Appropriate homeownership levels - are generally defined as the homeownership level associated with credit qualified borrowers. Credit qualification means those borrowers have the capacity and willingness to repay their mortgages. A significant criticism of the U.S. Government following the 2007-08 Financial Crisis was the enabling of lending to credit unqualified borrowers. Related causal conclusions of the U.S. Government's Financial Crisis Inquiry Report included "Collapsing mortgage-lending standards" and "Widespread failures in financial regulation and supervision." As such, not all people are credit qualified for mortgages. Pretending like all people are credit qualified (Collapsing standards) and then pretending like the loans were good (Widespread regulatory failures) is certainly a recipe for disaster.


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