Overzealous intervention dooms the market

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Article Highlights

  • Government guarantees for mortgages pose needless risk to homeowners and taxpayers.

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  • Government guarantees for mortgages suffer from three flaws: the inability and unwillingness to price for risk, asset allocation distortion, and the politicization of lending.

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  • The alternative to Subprime 2.0 is a home finance market based on tried and true principles.

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Editor’s note: This piece originally appeared on June 20, 2013, in The New York Times’ Room for Debate in response to the question: Does it make sense to encourage homeownership through entities like Fannie and Freddie and through tax policies?

Those who want government guarantees for mortgages see them as a path to encourage homeownership and market stability, but instead guarantees pose needless risks to homeowners and taxpayers. Government guarantees suffer from three flaws: the inability and unwillingness to price for risk, asset allocation distortions, and the politicization of lending.

At a recent conference on housing finance reform, community and industry advocates called for a replay of the failed government “affordable housing” experiment begun in the early 1990s. That experiment cost America’s homeowners trillions as loose lending drove the homeownership rate and home prices to unsustainable levels.

Proponents of Subprime 2.0 say a government centric housing system is necessary to assure flexibility, accessibility, affordability and stability. We know from the last experiment that “flexibility” means subprime lending, “accessibility” means entitlements, “affordability” means subsidies, and “stability” means increasing leverage during boom times. For example, achieving flexibility would require the widespread use of subprime loans with low down payments, low credit-score requirements and high debt-to-income ratios.

Such a system is doomed to failure. The alternative is a home finance market based on tried and true principles:

First, the long-term credit performance of the housing mortgage market requires sound underwriting practices that result when a preponderance of loans are of prime quality.

Second, traditional prime mortgages performed well in the past because lenders required sizable down payments, solid borrower credit histories and a well-demonstrated capacity to cover household obligations.

Third, subprime mortgages lack one or more of these pillars, resulting in default rates that are many multiples of those for prime loans.

Fourth, all programs intended to help low-income families become homeowners should be on budget and should limit risks to both homeowners and taxpayers.

When policy makers recognize these four principles, the nation will have a robust housing finance sector, in which the private market and the government play appropriate and complementary roles.

Edward J. Pinto, a former executive vice president and chief credit officer of Fannie Mae, is a resident fellow at the American Enterprise Institute.

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Edward J.
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