It's looking more and more like the Uncle Sam is going to keep his hands in the mortgage market. The Obama administration and two major financial lobbying firms appear to be on the same page about a plan that would require lenders to pay a fee to the government for guarantees, according to the Wall Street Journal. That probably seals the plan's fate. My colleague Megan McArdle says this doesn't make sense. She right, but I'd like to take this a step further: the financial industry would only fight for such a plan if it includes an implicit subsidy.
In questioning the plan, Megan writes:
After all, what is the appropriate cost of the guarantee? Why, it's the amount that the guarantee is reducing the cost of the mortgage. Since the banks would then charge this amount to the homeowners, the net effect should be zero.
This relates to an argument I made back in May when this plan was proposed by a few academics. One way to capture a mortgage risk premium is to require the borrower to pay for it with a higher interest rate and/or larger down payment. Alternatively, the bank could require that the homeowner pay for default insurance from a private guarantor, which would result in same cost, in theory. Of course, if the government instead provides for that insurance, then again, the overall cost should again be the same -- and ultimately be paid by the borrower.