Housing Finance Reform
By Arnold Kling
Our alternative approach is to ensure that only prime quality mortgages, which comprise the vast majority of US mortgages, are allowed into the securitization system. The very low delinquency and default rates on prime mortgages will be attractive investments for institutional investors and enable the housing finance system to function effectively with no government support. This will eliminate the potential for additional taxpayer losses in the future, and allow the eventual elimination of Fannie Mae and Freddie Mac.
They offer four principles with which I agree. 1. The housing finance market can and should function without government support. 2. Any regulation should focus on ensuring mortgage credit quality. 3. All forms of housing assistance should be explicit and on budget. 4. Fannie and Freddie should be eliminated over time.
One could argue that (4) is not a principle–it just follows from (1) and (3).
The only way in which I differ is that I am not sure that as government withdraws from housing finance we will see private securitization emerge. Instead, I think we might see a reversion to the originate-and-hold model, but with a significant differential between the interest rate on 5-year adjustable loans and 30-year fixed rates loans, so that consumers begin to shift away from the latter.
In order for the buy-and-hold model to come back, a lot more capital would have to come into the banking system, whereas now a lot of that capital is in the shadow banking system. I think that can happen as a natural, evolutionary process. But things could evolve differently from what I expect.