Maybe Federal Mortgage Guarantees Aren't Inevitable

The financial regulation bill passed this summer left out one key component: housing finance policy. While there is broad agreement that government-sponsored mortgage companies Fannie Mae and Freddie Mac were a disaster, there isn't a clear answer to how to reshape the mortgage market to function better going forward. Since Democrats in didn't feel like approaching this very messy debate when drafting the summer's financial regulation bill, they just punted to the next Congress. At this time, little has changed, as the government continues to back most new mortgages in the U.S. Early talks implied that the government would ultimately continue to stand behind most mortgages, but suddenly housing policy's fate isn't looking as inevitable.

Back in August, the Treasury opened up the housing finance policy discussion with a big conference consisting of investors, economists, bankers, and other industry experts. At that time, it looked like there was a fairly broad consensus advocating for explicit government mortgage guarantees, where lenders would pay a fee for that service. But a Wall Street Journal article by Nick Timiraos and Deborah Solomon from this weekend casts some doubt on that seemingly unavoidable outcome:

Top administration officials, including Treasury Secretary Timothy Geithner, have publicly discussed the merits of a limited but explicit government guarantee of securities backed by certain types of mortgages. Investors, academics and the housing industry say such a guarantee is needed to maintain a healthy market, particularly for long-term, fixed-rate loans that remain a keystone of U.S. housing.

But the administration is divided over whether a backstop for new loans would be needed when markets return to normal, a process that could take several years. Some worry any guarantees expose the government to too much risk, as the $134 billion in losses incurred by Fannie and Freddie indicate.

This is a surprise, because as the excerpt above says, pretty much all sides agreed at the August conference that some form of government guarantee was necessary. Investors love the idea because it eliminates their risk. Banks love the idea, because they can originate all the mortgages they want to sell to investors. Affordable housing advocates love the idea because government guarantees would keep mortgages cheap. The government loves the idea because it believes it can price the risk properly and points to its depository insurance as proof.

So who doesn't like the idea? Libertarians who want a freer market and less government involvement argue that there are both practical and philosophical problems with government mortgage guarantees. The first are kind of obvious - just look at Fannie Mae and Freddie Mac. They're a great lesson for how government mortgage guarantees can go horribly wrong. Philosophically, it's difficult to justify pricing a product lower than the market will pay for it, which is essentially what a government guarantee would do.

But there don't appear to be too many free market libertarians in the Obama administration, so it's hard to understand where this disagreement is coming from. As mentioned, progressives, moderate Democrats, and even moderate Republicans all generally agree that government guarantees are a good idea. What is the administration scared of?

There may be two obstacles it sees. The first is the possibility that the libertarians are correct. There are other countries that have healthy, functioning mortgage markets without government guarantees. And there might also be some legitimate doubt that the government really can price these guarantees properly without political priorities getting in the way.

The second could be those free market libertarians: they might not be making waves in Washington yet, but they're coming. As the housing finance policy debate begins in January it will do so in a very different Congress. Not only are there more Republicans who might not love the idea of continued government involvement in the market, but there are some tea partiers who consider themselves free market libertarian types more likely to be vehemently against government mortgage guarantees. The Treasury could be anticipating their distaste for these guarantees and intends to draw up an alternative or compromise. Remember, no law can pass without the House's consent, where Republicans will hold a majority.

This is a very positive development. Government mortgage guarantees should be controversial for reasons explained in the links below. Even if guarantees are the policy ultimately adopted by the government, some heated, vigorous debate would be welcomed in getting there. All options need to weighed against one another, and all positives and negatives of the various plans should be considered. If government guarantees really are the best policy, then Congress should be able to convince even the most outspoken skeptics of their necessity.

For some posts on why federal mortgage guarantees should be questioned, see the following:

Government Mortgage Guarantees Will Be Sneaky Subsidies

Housing Finance Agency Head Worries About Mortgage Guarantees

Fannie and Freddie Show the Danger of Mortgage Guarantees

Reforming Fannie and Freddie: No Escape for Taxpayers