Discussion: (0 comments)
There are no comments available.
View related content: Public Economics
The new Congress, with a Republican House and a much narrower Democratic majority in the Senate, offers an opportunity for real reform of the housing-finance system. Up to now, most of the “reform” ideas floating through Washington have been designed to maintain a federal role. But if the 2010 election means anything, it is that the American people want the government to stop pursuing policies that put the taxpayers at risk for private failures.
The policy case against further government support of housing seems overwhelming. It is only 20 years since the savings-and-loan debacle, which arose from the government’s effort to assure a steady flow of funds for housing. Beginning in the 1930s, interest rates on bank deposits had been capped by the Federal Reserve. In 1966, the cap was modified so that savings-and-loan associations could pay a quarter-point more than banks. With that support, the S&Ls quadrupled in size in the next 13 years.
When the rise of money-market mutual funds forced the government to abandon interest-rate controls entirely, many S&Ls were unable to compete in the unregulated market and became insolvent. In early 1989, the government stepped in. The ultimate cost to taxpayers was $150 billion.
The obvious lessons were ignored. Instead, the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac were allowed to take over the business of the S&Ls, buying and holding mortgages with an implicit government guarantee. As off-budget vehicles with virtually unlimited resources, Fannie and Freddie were ready-made for political exploitation, and advocates for low-income housing seized the day.
In 1992, Congress saddled Fannie and Freddie with a mission to support “affordable housing.” This meant supplying credit for borrowers at or below the median income–mostly through subprime loans–and required that the GSEs reduce their underwriting standards by lowering down-payment requirements and buying other risky loans. But the new mission cemented their congressional support, and so Congress, joined by the housing industry, protected the GSEs from restrictive regulation almost to the day of their final collapse and government takeover on Sept. 7, 2008.
Research by Edward Pinto, a resident fellow at the American Enterprise Institute who was chief credit officer of Fannie Mae in the 1980s, has shown that by 2008 half of all mortgages in the U.S.–27 million–were subprime and other high-risk loans, often with little or no down payments by borrowers. Because of their affordable- housing requirements, the GSEs bore the risk of default on 12 million of these mortgages. The Federal Housing Administration (FHA) and other government agencies insured or held an additional five million. And banks under the Community Reinvestment Act, and other mortgage providers under a Department of Housing and Urban Development program, made another 2.2 million.
Thus, more than 19 million subprime loans were the responsibility of taxpayers, courtesy of the federal government’s housing policies. The balance, slightly less than eight million loans, were securitized by Countrywide and other private issuers.
When the housing bubble began to deflate in 2007, these loans started to default in unprecedented numbers, driving down housing prices, forcing Fannie and Freddie into insolvency, and weakening financial institutions in the U.S. and around the world. Last October the GSEs’ regulator, the Federal Housing Finance Agency, estimated that the final cost for bailing them out would be between $221 billion and $363 billion.
Taxpayers might wonder what they got for all these costs. Certainly not a superior home-ownership rate–the U.S. ranks 17 among developed countries–well behind Chile, Italy and Israel, for example. Certainly not stable prices.
As other countries have shown, a housing system exposed to normal financial-market fluctuations is fully capable of meeting a nation’s needs. Covered bonds, in which a bank sets aside a portfolio of mortgages to back up its obligations to bond buyers, are used widely in Europe and are generally treated as a high-quality security in the financial markets. If the mortgages don’t fully compensate the bondholders, they can recover from the bank itself. No government support is involved, other than a rule that requires mortgages to meet the kind of quality standards that prevailed in the U.S. before affordable-housing goals were imposed on Fannie and Freddie.
The U.S. housing market is so large that banks alone cannot supply all the necessary mortgage credit. The securitization market, which is a mainstay of the credit-card and auto-loan markets, has a place. The collapse of mortgage securitization in 2007, like the insolvency of the GSEs, was caused by the securitization of subprime mortgages. Securitizations of “jumbo” mortgages–those larger than Fannie and Freddie were allowed to buy–lost value in the recession that followed the financial crisis, but they have been recovering.
Privatization or elimination of Fan and Fred is necessary to revive the securitization market, which cannot compete with the GSEs’ subsidized rates. But as long as the GSEs are controlled by the government, the size of the mortgages they are able to buy can gradually be reduced. This can be done in, say, $50,000 increments every six months. As the GSEs are slowly removed from a portion of the market, securitization will take their place. When the GSEs’ permitted level of mortgage acquisitions has been sufficiently reduced so that they are no longer important market factors, they can be closed down or privatized.
As we have learned at such great cost, housing bubbles can cause mortgage underwriting standards to dangerously deteriorate, so some regulation to assure that mortgages retain prime quality will be necessary to prevent this from happening again. The FHA can continue to insure mortgages from low-income borrowers, but these loans must also have clear standards so taxpayers are not put at risk again.
With these reforms, the distortions introduced by government guarantees and social policies will come to an end and the U.S. housing industry–and not U.S. taxpayers–will be taking the risks associated with housing finance. This is the way every other wealth-producing industry works, and the new Congress should assure that housing does not again make itself a ward of the government.
Peter J. Wallison is the Arthur F. Burns Fellow in Financial Policy Studies at AEI.
The 2010 election shows that the American people want the government to stop pursuing policies that put taxpayers at risk for private failures. The new Congress offers an opportunity for real reform of the housing-finance system.
There are no comments available.
1150 17th Street, N.W. Washington, D.C. 20036
© 2014 American Enterprise Institute for Public Policy Research