The argument you usually hear for why the government should guarantee mortgages is that commoditizing the assts without risk of credit losses will make them highly liquid and cheaper for borrowers to attain. Some may find that a compelling reason, even though taxpayers just cover that risk premium instead of the borrowers. But the real foundation for the federal government must guarantee mortgages stems from a deeper concern: when a recession and credit crisis hits, the mortgage market could close down entirely. So even if you're okay with mortgages becoming more expensive, is there any way to eliminate the government guarantee without risking periods of time when no one can get a mortgage?
Let's consider the most recent example of a credit crunch: the financial crisis. Despite the securitization market closing down and banks struggling to get cash to lend, the mortgage market remained open. One reason why was precisely what advocates for government guarantees would cite: the GSEs continued to provide funding for and back mortgages. As a result, the market kept on chugging along, albeit it at a slower pace.
But this wasn't the only factor. The Federal Reserve also purchased over a trillion dollars in mortgage securities. Why not ensure the mortgage market will stay open by relying on the central bank to step in during a credit crunch and perform this function when necessary?
Think about how this would work. The Fed could create some underwriting criteria that mortgages must meet in order for it to purchase them. The rules would be relatively conservative. It could then purchase a trillion or so in mortgages for as long as the credit crunch continues. Then it would be able to easily sell those securities once the market returns to normal -- probably at a profit if origination follows the criteria it dictates. As a result, its mortgage portfolio would be counter cyclical and temporary.
This is a better alternative than the permanent government guarantee option for a few reasons.
First, it would be an emergency market intervention and not a permanent presence of the government in the private sector. This would allow the market to function more effectively in normal times, with fewer distortions created through perpetual government involvement. The private sector would never get crowded out as long as it has a demand for mortgage assets.
Second, the purchase program would function as just another form of money supply loosening. This happens during economic downturns anyway, so the Fed would just have this as another tool in its box to dust off when a bad recession hits.
Finally, the Fed is independent -- or at least less swayed by the political winds than most agencies Washington lawmakers have more control over. The U.S. learned an important lesson through the failings of Fannie and Freddie. When an agency that plays a role in the private sector becomes politically entrenched, bad things can happen. This will always be a risk as long as the government controls how mortgages are guaranteed or purchased. The Fed has a better chance at using discretion when purchasing assets than a government-sponsored entity.
We want to hear what you think about this article. Submit a letter to the editor or write to email@example.com.