This is a summary of a working paper available at the links for which comments are welcome. (An earlier post on related topics appeared here.)
Download the paper (500KB pdf).
—-
The Administration will soon propose legislation to address the future of the US housing finance system, and it’s a sure bet that this will include re-incarnating Fannie and Freddie in some form. Prominent Republican politicians have also recently called for “privatizing” these entities. This is sheer folly. The problem with keeping Fannie and Freddie or an alternative government sponsored capital market hybrid that seeks to limit and/or price government backing is that policymakers have always done just that! It was investors, not policy-makers, who conferred “agency status” on Fannie and Freddie in spite of their prior ill designed privatizations.
Regardless of whether you believe they were leaders or followers in the sub-prime lending debacle—and the evidence overwhelmingly favors the former view–they have always represented a systemic risk and are inherently inconsistent with a competitive financial system. There are significant roles for government in a competitive market oriented housing finance system, but this isn’t one of them.
Public deposit protection is here to stay. Nobody is suggesting getting rid of the Federal Deposit Insurance Corporation, but public protection requires appropriate regulation.
Whether homeownership subsidies such as the mortgage interest deduction are appropriate is an ongoing debate. Nobody is suggesting getting rid of all homeownership subsidies, but credit subsidies for low-income borrowers and other politically preferred groups should be budgeted, targeted and separated from finance.
Discrimination in lending that is not based on the ability to pay is illegal. Nobody is suggesting relaxing current anti-discrimination laws and regulations, but competition often mitigates all forms of inappropriate lending discrimination better than regulation.
Capital market financing will remain necessary. Nobody is suggesting getting rid of the FHA/Ginnie Mae program or the almost equally massive Federal Home Loan Bank System, but reforms of these programs are necessary after the housing markets recover.
Private label mortgage securitization contributed to the sub-prime lending debacle. Nobody condones the abuses, but private label securitization worked well until regulatory distortions encouraged securitizers to bypass the private mortgage insurance industry, the traditional gatekeepers responsible for preventing excessively risky lending.
A competitive market oriented system serves qualified home borrowers and lenders best but has few political constituents. Politicians much prefer the deferred off budget costs of Fannie and Freddie but the long run costs of delivering subsidies that way far exceed the benefits.
The four steps necessary to restore a stable competitive market oriented housing finance system are: