My Paper on Housing Finance Reform
By Arnold Kling
Any attempt to reengineer a housing-finance system with a new set of government-guaranteed entities would entail all of the risks of restoring the existing GSEs, plus more. The taxpayers would be exposed to similar potential hazards, but with new and inexperienced organizations engaged at the level of enterprise management and regulatory oversight.
A sentence that may surprise:
Before we bury Freddie Mac and Fannie Mae, we should praise them.
Overall, I suggest either going back to some version of the S&L model or some version of the GSE model. In either case, the focus should be on minimizing taxpayer risk, not on trying to tilt the housing market in some particular direction. If you are going to comment, first read the paper.
The paper is part of a compendium called Five Proposals for New Housing Finance System in the United States. Perhaps it should say six, given that my paper includes two.
Of course, what a lot of the papers are doing is saying, “Let the market work,” which means no real concrete proposal. We can make guesses as to how the market will adjust, but we cannot play the game that a more statist reformer could play, of saying exactly what our plan is supposed to do.
For example, Dwight Jaffee thinks that private securitization will come back stronger than ever. Peter Wallison is equally confident that the mortgage market will do fine without a government guarantee.
However, the way I see it, too many investors, particularly foreign investors, have been spooked by mortgage securitization. Yes, in theory, all that the securitizers need to do is tighten underwriting standards, but will the investors trust them to do that? My guess is that if we do not have Freddie, Fannie, or some other government guarantor, the advantage in mortgage lending will shift back to banks and away from Wall Street. Nothing wrong that. In my paper, it’s the preferred outcome.
Unlike me, Lawrence J. White would be willing (although this is not his first choice) to try a new form of government guarantee. As I understand it, the government would basically match private mortgage insurance, with the government’s portion priced in line with the private portion. I can think of plenty of ways that the private mortgage insurers could game this, and what worries me is that there are ways that I have not thought of that also would work.
Last but not least, Michael Lea and Anthony B. Sanders offer an eclectic vision for a post-GSE future. That is, they see a role for banks, for private securitization, and for changes in mortgage products.
We wrote our papers independently. As a result, there is considerable overlap and redundancy. All of us see the arguments for a government role in the mortgage market as very weak. All of us see the private sector as capable of adapting to fill the gap left as Fannie Mae and Freddie Mac are phased out. All of us see a return of higher down payments and stricter underwriting standards as the key to creating a mortgage market that investors can trust.
There is even a fair amount of overlap between our papers and The Treasury Report provided by the Obama Administration. All of us can envision a world without Freddie and Fannie. However, I worry that some new guarantee mechanism will be created that is ultimately even more dangerous.
All of these proposals run counter to the narrative that the private sector cannot be trusted to deliver a safe mortgage system. Our proposals assume that the private sector has an incentive to avoid taking unreasonable risks. One could argue that this is simply a reversion to the view that Alan Greenspan said that he held mistakenly prior to the crisis.
I would put it slightly differently. I have very little faith that the private sector will always avoid taking unreasonable risks. However, I have even less faith that regulators will have the wisdom to see the risks that private agents are missing.
Remember that up until very late in the game, the criticism that Congress and regulators were directing at lenders was for turning down too many borrowers. What the government was pushing for was more lending to the “under-served” segments of the market.
Yes, there can be market misbehavior. But regulators may well, as in this case, amplify the problems rather than dampen them. This illustrates the aphorism that “Markets fail. That’s why we need markets.”