Breaking Down the Housing Policy Debate

With the Wall Street regulation bill behind Congress, it has already begun to tackle the next big fiscal issue: housing policy reform. With the government sponsored entities (GSEs) Fannie Mae and Freddie Mac shaping up to be the most costly of all bailout recipients, it's a problem that deserves serious attention. What should Washington decide?

First, here's a spoiler for how the debate will end: the government will maintain its strong influence in the housing market for decades, if not centuries, to come. The reason why has to do with a very unusual alliance when it comes to housing policy. Bankers and progressives will find themselves on the same page. Banks want government guarantees so they don't have to worry about risk and can keep making easy money off real estate. Progressives want government to expand home ownership so that everyone can live the American Dream.

The progressive point might seem obvious enough -- they're all about equality. Yet aren't banks all about getting the government out of their way? Sometimes they are. But when the government is shoving money into their pockets, they welcome it with a wide smile. Banks aren't libertarians; they're capitalists. They're against the government's interference when it eats into their profits, but for it when it's to their advantage. It's a practical stance, not a principled one.

This was again made clear in a House committee hearing today on Capitol Hill exploring housing market policy. When Rep. Kanjorski (D-PA) asked who among the panelists would like to see the government's influence in the mortgage market disappear entirely, only one panelist raised his hand -- Anthony Sanders, a professor from the libertarian-leaning Mercatus Center at George Mason University. The other panelists included several industry participants and a scholar from the progressive think tank the Center for American Progress.

There are two issues here that need to be separated, because they're really unrelated. One is whether or not the government should have a role in helping low-income individuals gain access to the housing market. That's simply a normative question, not an economic one. If you think it's unfair that poorer Americans can't buy homes, then you believe the government has an important role to play here. But this effort would probably only amount to the government having tens of billions of dollars in mortgage exposure, not several trillion as it does now.

The second question is whether the government needs to provide liquidity to the mortgage market. Liquidity is one of the jargon terms you'll begin to hear thrown around with regard to the mortgage market over the next year. Liquidity technically means the ability to convert an asset to cash quickly, but in this context it mostly reflects banks ability to get funding for mortgages they originate. Since the GSEs had traditionally guaranteed or purchased most mortgages, it had been easy to get money for mortgages banks create.

Without government support, mortgages aren't a particularly desirable investment for banks to fund on their own. They generally offer relatively low interest rates, long terms, fixed interest, and can be refinanced at the borrower's whim. But if they're guaranteed by the government, suddenly they don't look so bad. The risk premium disappears and anyone will buy it. Fee income alone might be reason enough originate more.

So what happens if the government's widespread support of mortgage liquidity ends? Then, the U.S. would be like virtually all other countries -- they don't have GSEs like Fannie and Freddie. They rely on other ways to make sure that banks are funding mortgages, like well-developed covered bond markets. Their mortgages might be a little more expensive without government guarantees, but their taxpayers are consequently shielded from massive housing bubble-created losses.

There is a legitimate problem of what happens during a credit crunch if the government pulls out of the mortgage market entirely. One solution might to put emergency programs in place, like a mortgage-backed security purchase program at the Federal Reserve, to make sure credit can continue to flow when a crisis hits. You don't need GSEs for that.

Eventually, Americans need to choose their fate. In one scenario, you would have a nation with a higher rate of home ownership and cheaper mortgages, but where taxpayers are exposed to the specter of mortgage market bailouts. It also includes an implicit transfer payment from renters to homeowners. That's the America from the past several decades. In the other scenario, you would have a nation with a slightly lower rate of home ownership and slightly more expensive mortgages requiring bigger down payments, but where taxpayers have little to no exposure to housing market risk. Which would you choose?