Government

Should The Government Be In The Mortgage Business?

This year, the federal government guaranteed the vast majority of mortgages issued in this country. And about half of all of the outstanding mortgages in America — not just those issued this year — are now backed by the government

That means that if the guy down the street doesn't pay back his mortgage, there's a good chance that every taxpayer in the country is on the hook.

It's tough to find anybody who thinks this is a good system. Sure, there may be some role for the government in the mortgage market — helping qualified low-income people buy homes, for example.

But ever since Fannie Mae and Freddie Mac failed during the financial crisis and were taken over by the government, there's been widespread agreement that we need to come up with a new system. The bailouts of Fannie and Freddie have already cost taxpayers well over $100 billion.

President Obama's housing secretary has said that the "government's footprint in the housing market needs to be smaller than it is today." Republicans agree. Hashing out the details is likely to be one of the big economic policy debates of 2011.

Fannie and Freddie play a key role in the mortgage market. Their job is to buy mortgages made by banks, then sell bundles of those mortgages to investors, along with a guarantee that the mortgage will be paid back. This creates a big, steady market for mortgages, which makes it easier for people to buy houses.

Fannie and Freddie were private companies until the crisis, but they were created and overseen by the government. So they occupied a weird space between public and private. The question now is who will do what Fannie and Freddie have traditionally done?

Yesterday, the CBO released a report that gives a useful overview of the possibilities — from a government-run agency that guarantees a wide range of mortgages, to some sort of hybrid, to a fully private system.

Here are a few of the pros and cons for each option, as described by the CBO:

1. Government-run

Under this system, a government agency would be created to guarantee a wide range of mortgages. It would be paid for wholly or partly by fees paid by borrowers.

Pros:

Steady flow of funds to the mortgage market, even during times of "financial stress."

"Most of the federal subsidies would probably flow to mortgage borrowers rather than to private financial institutions."

Cons:

"Greater federal presence could tilt the allocation of capital in the economy further toward housing and away from other activities."

"Taxpayers, rather than private financial institutions, would bear much of the credit risk on guaranteed mortgages."

2. Hybrid

In this system, private companies would charge fees and guarantee mortgages, and make profits or take losses depending on how the mortgages perform. The federal government would charge fees and issue limited guarantees, which would kick in under extreme circumstances if the private companies were wiped out.

Pros:

"Limit costs and risks to taxpayers" by having private companies take initial losses

During times of financial stress, limited government guarantees could help keep funds flowing to the market

Cons:

"Experience with other federal insurance and credit programs suggests that the government would have trouble setting risk-sensitive prices and would most likely end up imposing some cost and risk on taxpayers"

Might result in some of the same problems that arose with Fannie and Freddie: A market dominated by a few players who are likely to capture their regulators.

3. Private

Under this system, the government's active role in the mortgage market would be limited to affordable housing programs, such as the FHA. Everything else would be left to the private market.

Pros:

Would likely increase competition, which would "reduce the market’s reliance on the viability of any one firm."

May be the best way to "allocate the credit risk and interest rate risk" associated with mortgages

Cons:

Everyone might assume that the private companies would be bailed out by the government in a crisis, "weakening market discipline, reducing transparency, and creating moral hazard."

Taxpayers might still wind up on the hook for losses in a crisis, particularly if the risks wound up being borne by banks that are covered by the FDIC.

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