Why the US can’t scrap its dysfunctional system of financing homeownership

Housing funding should be put in the hands of private institutions—partially.
Housing funding should be put in the hands of private institutions—partially.
Image: Reuters/Mike Segar
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After months of robust home value appreciation, the US housing market recovery is on very solid footing. We can now begin to turn away from housing’s ugly recent history and start contemplating its future, specifically the future of housing finance.

That President Obama and representatives from both parties in the House and Senate have recognized this fact as well is encouraging. The president has taken his housing message directly to consumers, through means both conventional—speeches and talking points—and decidedly 21st century, accepting questions via social media during a recent event hosted by Zillow.

But for all the attention the president’s actions have generated, his largely non-controversial principles generally describe accepted points of consensus: Yes, we need more private-sector participation in the housing market. Having two government-sponsored entities (Fannie Mae and Freddie Mac) responsible for the securitization of the majority of mortgages written in this country is anathema to an economy as pro-market as the US.

And yes, we do want to ensure widespread access to low-cost, fixed-rate, 30-year mortgages. The 30-year, fixed-rate mortgage is the bedrock of the current housing finance system in the US. It has allowed tens of millions of low-income and middle-class buyers to achieve homeownership over the past several decades.

But outside of the current system, which most everybody agrees needs to be changed, it’s very difficult to have this particular flavor housing cake and eat it too.

There are currently two proposals for reforming the housing finance system. The first, more conservative proposal was recently introduced in the House of Representatives by representative Jeb Hensarling (a Republican from Texas). It would essentially fully privatize the mortgage market, leaving private capital to take on all the risks— and reap the rewards—of mortgage financing.

But for private lenders to accept that risk without any federal backstop, the 30-year, fixed-rate mortgage would become very expensive for the typical consumer as lenders charged more to take on more risk, and/or would require potentially very restrictive credit qualifications. The 30-year, fixed-rate mortgage would likely be replaced by adjustable-rate mortgages. I personally don’t think this would be such a bad thing (most other countries use them predominantly without major mishap), but most Americans disagree with me, and public policy should somewhat reflect public preferences.

The second, less conservative plan has been introduced in the Senate by senators Bob Corker (Republican from Tennessee) and Mark Warner (Democrat from Virginia). It would replace Fannie and Freddie with a single, government-backed entity, responsible only for insuring, for a fee, securities created by private lenders. Moreover, these lenders would have to absorb a 10% loss before the government steps in.

I am generally a very pro-market economist, and there is a powerful allure to the idea of a fully private mortgage system. Were I designing a new system from scratch, I might prefer the challenge of going fully private. Given enough time, I think we could find ways to address the problems of reduced mortgage access in a fully privatized framework.

But I’m also pragmatic. We’re not designing a system from scratch. In that sense, something similar to the Corker/Warner idea should be the pig iron from which we create the new housing finance plowshare. It would be easier to smoothly transition from Fannie and Freddie to a single insurance entity for mortgages (like the FDIC for bank deposits). It keeps a lot of elements of the current system—such as widespread access to the 30-year, fixed-rate mortgage—and it likely has some protections built in for rainy days, including keeping credit flowing even when fully private credit might dry up.

Of course, there is a third option. Now that the worst of the housing recession is behind us, and now that Fannie and Freddie are making the government (and by association, taxpayers) so much money, it might be very tempting to do nothing at all.

But this is by far the least palatable choice.

The time has come to move our mortgage finance system past the crisis-induced holding pattern it’s been in for so long. The consensus around an idea like that proposed by Corker and Warner seems to be growing. If that’s the case, it’s time to get something done.