China and its Discontents

Putting the Focus Back on Housing Policy

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With the release of the Treasury Department’s new white paper on housing policy, the administration has restarted a national discussion on reforming the GSEs (government-sponsored enterprises, Freddy Mac and Fannie Mae). The long and short of it is that they distort the market for mortgages, and contributed to the collapse of the economy by backing risky mortgage securities that later blew up. (they are not however the root cause and creators of those exotic securities; you can thank Wall Street for that) Our bailout of Freddy and Fannie has cost the government far more money than the stimulus or TARP ever cost. This entire set-up is rather strange, given that these are for-profit corporations with an arsenal of lobbyists.

What’s the government’s plan? I got curious when I read Ezra Klein write this bit: “But the government isn’t looking to dramatically change the role they play in the housing market. They’re just looking to get away from poorly designed institutions like Fannie and Freddie.” This seems like a contradiction – and I think he misread the report, although I agree with everything else he wrote in that post. The government’s stake in the mortgage market is going to be substantially altered. As Daniel Indiviglio writes, the government will still subsidize a small portion of mortgages for the poor and veterans through FHA and VA programs, but under any of the options provided by the Treasury Department, the U.S. government will gradually exit the 85% percent of the market it had previously inhabited.

The plan makes GSEs less and less competitive with private sources of funding, gradually winding down its influence on the mortgage market. Fees guaranteeing mortgages will rise, more private capital would need to be raised to cover credit losses, and larger mortgages will not qualify for government-backing. Next, the plan offers three options for a limited government presence on the market: completely private, no government role of any kind; a crisis funding mechanism that is so expensive that during good times it is never used, and in bad times much cheaper to ease a credit crunch; and a catastrophic guarantee reinsurance program. Indiviglio describes this better than I can: “Mortgages would pay a premium to obtain this insurance, but the first losses (up to some specified percentage) would hit whoever held the mortgage asset, whether it be a bank or investor. If losses exceed that first loss piece, then the government would cover the remainder. The government would use the guarantee fees it obtained to do so. That way, theoretically, taxpayers would not be harmed. Think of this as a little like depository insurance, where there’s a fund in place paid for by insurance premiums that the government uses to cover losses.”

This is all good. When it comes to housing policy, one major question will shape how you view all related policies: is universal housing ownership a worthy goal of U.S. government policy? I would say: not in of itself. Owning a house is not a smart decision for every single person. It might be the American dream, but we do more harm than good when we try to force it on people. I would suggest everyone also take a look at the GSE section of the Roosevelt Institute’s 2009 report on financial reform, “Let Markets Be Markets”. There’s a very good lecture from Raj Date included. The full report is here (pdf).