As housing finance policy proposals evolve, the question of reform becomes increasingly normative and less economic
How do you fix a $160 billion problem? Congress will face this question once the deficit deal is out of the way. It then must decide what to do with the troubled mortgage companies Fannie Mae and Freddie Mac. After the government seized the firms in 2008, the private market for mortgage financing shut down. At this time the government is purchasing or guaranteeing nearly all new mortgages. Nobody likes this result, and we're beginning to see some new bills that attempt to fix the problem. Determining which option is best might depend more on moral imperatives than economic theory.
The Treasury's Three Ideas
The Treasury waded into the debate in February when it provided three relatively aggressive alternatives to limit the government's role in housing finance. The first would only provide support for around 15% of the market, for low- to moderate-income borrowers. The second calls for a funding mechanism that comes to life only in emergencies like a credit crunch. The third would provide catastrophic guarantees on most mortgages, where private investors/lenders take the first loss on a loan-gone-bad.
The Treasury provided these options as possible ways to solve the problem, without committing to any one over another. That left Congress the opportunity to embrace them or ignore them altogether. Up to now, however, the only sweeping housing finance reform bills proposed remain in the earliest stage of the process, awaiting committee action.
Sammie Ram: Merging and Redefining Fannie Mae and Freddie Mac
One bill (.pdf) was proposed this week, sponsored by Rep. Gary Miller (R-CA). He hopes to wind down Fannie and Freddie and replace them with a new, single government agency to own and guarantee mortgages. He calls it the "Secondary Market Facility for Residential Mortgages." A fitting nickname might be "Sammie Ram" or "Sammie" for short.
Miller's bill puts an interesting spin on the debate. His background is in home building and his district lies is in the Orange County/Los Angeles, California area. As a result, he is very sympathetic to the realtor lobby, which strongly supports continued government support for the housing market. But it also has some conservative glimmers, attempting to ensure that the government's role doesn't become too broad.
So what would Sammie look like? First, it would be an explicit government agency -- not a quasi-private corporation like Fannie. The new agency's control of housing finance would be capped at 50% of the market, leaving the private sector to take on the rest. This limit could be relaxed in times of market distress, however. It would also focus on guaranteeing mortgages and would charge lenders a fee for this service to pay for any mortgages that incur losses. It would have reinsurance with the Treasury for any losses that exceed the value of its insurance fund.
Hoffin Gaes: At Least Five Mini-Fannies
An earlier proposal was offered in May by Rep. Gary Campbell (R-CA). Although Campbell doesn't have a background in the housing industry, he also represents Orange County, CA. His district was home to a couple of now defunct subprime mortgage companies like Ameriquest and New Century. He also supports continued government intervention in housing finance.
His bill, explored in detail here, would create at least five "Housing Finance Guarantee Associations." We'll nickname these "Hoffin Gaes" or "Hoffins" for short. Unlike Sammie, a these Hoffin would be a private firm. It would fund mortgages and would obtain a federal guarantee by paying the government a fee. In this sense, Hoffins would function like a bunch of mini-Fannies, except that the government guarantee would be explicit, instead of implicit.
The Silent Option: Just Let Fannie and Freddie Die Quietly
Of course, there's also some legislation out there that would simply wind down Fannie and Freddie without putting any new firms or agencies in their place. This option dismisses the assertion that the government must maintain a heavy influence in the housing market. Instead, it relies on the private sector to step in by reviving mortgage securitization and possibly the utilization of other markets like one in covered bonds.
Which Option Is Best?
The two sweeping bills out there, to create either Sammie or lots of Hoffins, have a lot of moving parts. Each hopes to maintain the government's influence in the housing market, but neither can ensure that housing bubbles will never occur again or that taxpayers will be completely shielded from losses. As long as the government is involved in guaranteeing mortgages, miscalculations can occur and bailouts may follow.
The authors of these bills, of course, will deny that could happen. In a perfect world, they'd be right. But we don't live in a perfect world -- we don't even live in a moderately predictable world.
And even if you do assume that the government will get its guarantee fees precisely right and escape future bailouts, taxpayer support for mortgage guarantees include an implicit subsidy. The government can finance mortgages cheaper than anyone else, because it doesn't care about profit. As a result, the return it gets for the risk it takes will be less than what the market would require. The difference between the market and government returns is a subsidy.
The question, then, is whether or not government support of the housing market is worth that price. Is ensuring that mortgages remain very cheap and widely available worth the subsidy that taxpayers provide? Answering this question isn't about economics: it's about morality. If you feel that homeownership is important enough that the government should subsidize it, then you might want to support one of the bills that leaves federal guarantees in place. If you believe that homeowners should pay whatever price for their mortgage that the market dictates, then you will oppose these measures.
That's where the housing finance policy debate gets messy. Anytime an issue boils down to a normative question, you cannot easily reconcile its two sides. Logic breaks down when pure opinion is at the heart of a dispute.
At this time, a number of generally opposing groups support keeping the government's role in place. The powerful real estate industry, Wall Street, and affordable housing advocates all want mortgages to remain very cheap and widely available. It's only the staunch free market types that want the government out of the housing market. This latter group is much smaller and less influential than the former group, however. So we may very well see Sammie or a bunch of Hoffins replace Fannie and Freddie in the years to come. Both options leave taxpayer subsidies in place for the mortgage market and could result in future bailouts.
Image Credit: REUTERS/Mario Anzuoni