Since the collapse of Fannie Mae and Freddie Mac, American housing finance has essentially become a nationalised industry. The government now backs roughly 90 per cent of all new mortgages in the country, mainly through the failed mortgage finance companies that are in federal “conservatorship”. Washington therefore sets the price of mortgage finance – probably at the wrong level.
We have ample evidence of what happens when the government distorts the massive mortgage market. A significant contributor to the financial crisis was the government’s mispricing of risk, and the resulting perception that mortgages were effectively as safe as US Treasuries. To make matters worse, there is little evidence that these government subsidies substantially improved home ownership rates or affordability.
A bipartisan proposal to wind down Fannie and Freddie has been introduced in the Senate. It would provide government backing for new mortgages in return for stricter underwriting standards, a requirement that the private sector absorb losses of up to 10 per cent of the value of the loans, and the creation of an industry-funded mortgage guarantee fund to further shield taxpayers from the cost of any bailout. But without support in Congress, this proposal is likely to stall. There are legitimate concerns that it would leave the government with an outsize role in the housing market – and that it could make mortgage finance unaffordable for some households.
The sheer size of the mortgage book currently underwritten by taxpayers makes it unlikely that the government could retreat quickly from the housing market without causing widespread disruption. But the harmful distortions that government involvement causes can be removed straight away. The trick is to devise a system that combines the government’s financial muscle with the market’s ability to price risk. That is the cornerstone of a proposal that I have put forward with two Democratic colleagues in the House of Representatives, John Carney and Jim Himes.
Under our plan the holders of mortgage-backed securities would absorb losses of up to 5 per cent of their value. The remaining 95 per cent would be covered by insurance, which would be provided jointly by the government and the private sector. Our rules would require at least a 10th of this insurance coverage to be purchased from private sources. The portion supplied by the government would have the same price as the private component, and it would insure against precisely the same risks. Consequently the market – rather than government agencies – would determine the price for insuring mortgage risk, eliminating the damaging distortions that exist today. At the same time, the government would ensure that the market retained enough capacity to provide affordable homes for American households.
Over time our plan would give private capital a greater role, pushing down the government’s share of the reinsurance market – since the private market, bearing the same risk and earning the same return, would have no incentive to use the government, save for lack of capacity.
Fannie and Freddie could conceivably return to the private sector and insure mortgages under our scheme. But they would receive no special deal from the government. This is essential for effective reform. Our plan would ensure that they do not return to monopoly status.
Over time the government needs to get out of the mortgage finance market that it has long dominated. But it must do so with care, to ensure that creditworthy American households have access to the affordable housing loans they need.
Ours is a pragmatic plan. It gives the government a smaller role than that advocated in the Senate, but a larger one than has been suggested in the House. It combines a gradual transition to private finance in the housing market with an immediate end to the government’s counterproductive role in setting the price of mortgage finance.
We desperately need to reform the mortgage finance system for the good of our economy, our taxpayers and the stability of the global financial system. Until we take important steps on housing reform, we will remain haunted by the ghosts of 2008.
The writer is a Democratic congressman for Maryland
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