Government mortgage guarantees lead to bailouts

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Article Highlights

  • No other developed country provides anything for housing like that provided by the U.S. government

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  • The Corker-Warner bill would expose the taxpayer to yet a third bailout

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  • Private actors will not be as inclined to take on excessive risk without the assurance of a government guarantee

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This piece is in response to the following debate question: Should the Federal government provide support to the mortgage market?

The answer to this fundamental question is no. Given the spectacular failures of U.S. housing finance and the enormous cost to taxpayers of two massive bailouts in twenty years, the housing industry should be required to show why it needs government support again.

No other developed country provides anything that approaches the support for housing provided by the U.S. government, and many of these produce higher homeownership rates, lower mortgage-interest rates and fewer losses when defaults occur. The Housing Finance Reform and Taxpayer Protection Act of 2013 (known as the Corker-Warner bill), would expose the taxpayer to yet a third bailout.

The taxpayer losses are the inevitable result of extending government guarantees or subsidies to the housing finance industry. The U.S.-backed finance system fails because of its connection to the government.

Government guarantees create moral hazard on two levels. First, by assuring the housing industry of a steady supply of underpriced funds, government support encourages overbuilding and speculation. In addition, by relieving investors of risk through a guarantee, government support makes it possible for mortgage originators to offer liberal lending terms such as zero or low down payment loans and loans to overextended and credit-impaired borrowers.

As the Obama administration noted in the report it issued in 2011, a private mortgage finance system reduces risk. "Risk throughout the system may also be reduced," simply because of the fact that it is private: "Private actors will not be as inclined to take on excessive risk without the assurance of a government guarantee behind them."    

Supporters of Corker-Warner point to the requirement for a 10 percent private, first-loss provision as protection against taxpayer loss. On the contrary, such a provision invites weakening over time and leads to political manipulation of the markets which will inevitably result in ever more risky mortgages. This is exactly what Congress did in 1992, which led to the housing bust of 2007.  

There is an alternative. The Protecting American Taxpayers and Homeowners Act of 2013 (the PATH Act recently approved by the House Financial Services Committee) would better protect the taxpayers and create a more stable mortgage market for all.

Before Congress considers any action on the future of housing finance, it should ask why does virtually the entire Government Mortgage Complex support Corker-Warner? This is the same lobby that supported Fannie and Freddie for many years. Why put the taxpayers at risk again?

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About the Author

 

Edward J.
Pinto
  • American Enterprise Institute (AEI) resident fellow Edward J. Pinto is the codirector of AEI’s International Center on Housing Risk. He is currently researching policy options for rebuilding the US housing finance sector and specializes in the effect of government housing policies on mortgages, foreclosures, and on the availability of affordable housing for working-class families. Pinto writes AEI’s monthly Housing Risk Watch, which has replaced AEI’s FHA Watch. Along with AEI resident scholar Stephen Oliner, Pinto is the creator and developer of the AEI Pinto-Oliner Mortgage Risk, Collateral Risk, and Capital Adequacy Indexes.


    An executive vice president and chief credit officer for Fannie Mae until the late 1980s, Pinto has done groundbreaking research on the role of federal housing policy in the 2008 mortgage and financial crisis. Pinto’s work on the Government Mortgage Complex includes seminal research papers submitted to the Financial Crisis Inquiry Commission: “Government Housing Policies in the Lead-up to the Financial Crisis” and “Triggers of the Financial Crisis.” In December 2012, he completed a study of 2.4 million Federal Housing Administration (FHA)–insured loans and found that FHA policies have resulted in a high proportion of working-class families losing their homes.

    Pinto has a J.D. from Indiana University Maurer School of Law and a B.A. from the University of Illinois at Urbana-Champaign.

  • Phone: 240-423-2848
    Email: edward.pinto@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: 202-419-5212
    Email: emily.rapp@aei.org

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