Cheap Mortgages, America's Hidden Entitlement

Washington is consumed with shrinking government and cutting spending. But voters may be loathe to give up its benefits.

Amid all the clamor about entitlement reform during the struggle to raise the debt ceiling, one enormous cost - and potential source of future saving - largely escaped scrutiny: the billions of dollars the United States spends to support the mortgage market. Even before the 2008 financial crisis, the government assumed the credit risk on most loans, which allowed banks to offer better rates, but ultimately left taxpayers footing the bill when the housing market collapsed: $138 billion and counting.

During the crisis, the government became even more involved in the mortgage market by rescuing Fannie Mae and Freddie Mac and agreeing to backstop larger loans. This furnished enough liquidity to prop up the housing market and helped bring about the low mortgage rates of the last three years. But getting in has proved much easier than getting out. Today, the government backs 95 percent of new loans, leaving taxpayers more exposed than ever.

That could finally be about to change. After next month, federal loan limits in expensive areas like Boston, New York, and Los Angeles are set to decline from $729,750 to $625,500. Had the lower limits applied last year, the government would have backed 50,000 fewer loans. But even this modest pullback may not happen. At the urging of homebuilders and realtors, lawmakers in both parties want to extend the higher limits, possibly for good. It's an early skirmish in the larger battle over the government's proper role in the mortgage market. And the issue isn't just when to pull back, but whether to do so at all: Many Americans have come to regard cheap mortgages as an entitlement.

The question of how to proceed has vexed liberals and conservatives alike. No one wants to return to the old system, in which Fannie and Freddie -- ostensibly private enterprises -- kept profits for themselves and stuck taxpayers with losses. But beyond that, there is little agreement. Liberals tend to support government intervention as a means of subsidizing home ownership for the poor and middle class; most conservatives would prefer to let private markets take over.

In theory, the U.S. could go the way of most European countries and stop guaranteeing mortgages altogether, thereby protecting taxpayers from budget-busting losses like the ones just incurred here. (Subsidies to advance home-ownership among the poor could be delivered directly.) This would force banks to absorb the interest-rate and credit risk from their loans, but the added risk would be passed along to borrowers in the form of higher rates, and could even put an end to the traditional 30-year fixed-rate mortgage -- the foundation of the US housing market, although it is rare in other countries.

Would Americans accept such a radical change? Republicans sure don't seem to think so. Although many argued loudly (and rather speciously) that government interference in the mortgage market was the primary cause of the financial crisis, they have mostly fallen silent since winning back the House last fall; legislation to abolish Fannie and Freddie has languished.

Instead, the recent credit downgrade and new fears about the weakening economy make it likely that Congress will once again extend the emergency interventions in the mortgage market. The White House officially opposes doing this, although it will probably relent.

After that, a good idea for what to do next comes from Representative Gary Miller, a California Republican. Miller is a real-estate developer and former builder, so his conservatism is leavened with actual experience. He'd like to merge Fannie and Freddie and keep them under the government's auspices, while removing the profit imperative that got them into so much trouble. The merged companies would continue to buy mortgages and resell them to investors with explicit government backing. But that's all they'd do. From the standpoint of someone buying a home, things wouldn't seem much different.

This plan would satisfy neither side completely, and would especially upset the purist Republicans now in the ascendant, for whom any role for government is grounds for opposition. But most politicians, even if they don't say so, understand this basic fact: For all that voters like to complain about government, most would be angry if forced to give up the benefits it affords them.

Joshua Green writes a weekly column for the Boston Globe.

Image credit: Larry Downing/Reuters