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Future of Housing Finance Reform

Future of Housing Finance Reform

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David Min explains why a government role is necessary in mortgage markets in the first of a new weekly series of memos on housing finance reform.
David Min explains why a government role is necessary in mortgage markets in the first of a new weekly series of memos on housing finance reform.

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Published by: Center for American Progress on Nov 05, 2010
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1Center or American Progress | Future o Housing Finance Reorm
Future of Housing Finance Reform
Why a Government Role Is Necessary for SmoothlyFunctioning Mortgage Markets
David Min November 2010
Early nex year, Washingon housing and nance policymakers in he Obamaadminisraion and on Capiol Hill will be deep in debae abou wha o do wihhe naion’s wo morgage nance gians, Fannie Mae and Freddie Mac, boh o  which are now in ederal receivership aer operaing as “governmen-sponsoredenerprises” in order o provide suppor or homeownership across our counry.Fannie and Freddie, o course, are boh cosly casualies o he recen housingand nancial crises aer decades o providing morgage nance o middle-class Americans, so guring ou how o replace hem—and he uncions hey serve—is one o he key policy decisions Washingon will make in 2011.Many conservaives wan o remove any governmen role rom he morgagenance markes, leaving privae markes o mee he morgage needs o U.S. resi-denial home buyers. Mos progressives recognize ha our counrys hisory andhe experience o many oher counries sarkly illusrae he aws inheren in he“purely privae” approach avored by conservaives. A ull wihdrawal o he ederalgovernmen rom he morgage markes would lead o radical and caasrophicchanges in he U.S. morgage markes and hus our housing markes, including:
Limied availabiliy o long-erm, xed-rae morgages
Sharp increases in he cos o morgages
Large reducions in he availabiliy o morgage credi
 A higher sysemic suscepibiliy o housing bubbles
 A lack o morgage credi during economic downurns
2Center or American Progress | Future o Housing Finance Reorm
Tis memo will deail why all o hese oucomes are ineviable i he ederalgovernmen plays no role in our morgage nance markes. Subsequen memos inhis series on morgage nance policy and housing policy will address oher issuescriical o he upcoming debae over how o reorm he housing nance sysem.
History shows us the limitations of a purely private mortgage market
Prior o he inroducion o he major housing and nance reorms o he 1930s(which esablished he Federal Housing Adminisraion, he Federal HomeLoan Bank Sysem, he Federal Deposi Insurance Corporaion, and Fannie Mae,among ohers), he Unied Saes had a morgage sysem ha closely resembledhe purely privae sysem ha conservaives are arguing or oday. From our con-emporary perspecive, his sysem was a oal ailure, demonsraing he perils o he morgage sysem ha conservaives would have us adop.Residenial morgages prior o he 1930s had many o he same eaures as heunregulaed morgage loans o he 2000s, wih producs similar o he subprimemorgages and so-called Al-A morgages—hen as in he 2000s hey were shorerm (ypically 5-10 years), hey were ineres only, hey carried a variable rae o ineres, and hey eaured “bulle” paymens o principal a erm (unless borrow-ers could renance hese loans when hey came due, hey would have o pay o he ousanding loan balance).Moreover, morgages in his earlier era had high down paymen requiremens, ypi-cally more han 50 percen, and were oered a raes much higher han he ones we ake or graned oday. Morgage nance was very expensive as well. As FederalReserve Chairman Ben Bernanke noed in his Augus 2007 remarks a JacksonHole, morgages were exraordinarily cosly by oday’s sandards, despie he acha hey were shor-duraion, ineres-only, and proeced by high down paymens.Tere were also large regional dispariies in morgage raes, wih dierenials o asmuch as 2- o- 4 percenage poins beween dieren pars o he counry.
 Because home morgages were scarce, expensive, and high risk, hey were eec-ively conned o a very narrow band o Americans, wih a much higher percen-age o home purchases being cash only. As a resul, homeownership was ar lessatainable han i is oday, wih a homeownership rae o 43.6 percen in 1940.
3Center or American Progress | Future o Housing Finance Reorm
Furhermore, even wih he predominance o hese lender-riendly eaures, hepurely privae morgage sysem ha exised prior o he 1930s was highly vulner-able o exreme bubble-and-bus cycles. During good imes, a lack o regulaory resrains mean ha here were no checks on excessive opimism and risk-akingin morgage lending; heavily leveraged morgage lending led o housing bubbleson a regular basis. And during bad imes here were no sources o morgage credio preven a reeall in he housing markes. As a resul, he U.S. morgage bankingsysem regularly suered banking panics every 5 o 10 years, which when i hap-pened had high coss or individual homeowners and deleerious consequenceson economic growh.
In response o he las o hese bus cycles, he Grea Depression, policymakersenaced a series o major banking and housing nance reorms, which ushered ina new and successul era o morgage marke sabiliy ha lased unil he 2008nancial crisis. Te key eaures o his new home morgage nance sysem were:
Srong risk regulaion across all morgage lenders o preven excessive risk-ak-ing and miigae he problem o housing bubbles
Broad availabiliy o aordably priced, long-erm, xed-rae morgages acili-aed by governmen-owned insiuions and governmen-sponsored enerprises,including he Federal Housing Adminisraion, he Veerans Adminisraion, heFederal Home Loan Bank Sysem, and Fannie Mae
Te provision o morgage credi during periods o marke conracion oreconomic downurns, which oen happened simulaneously, by hese sameinsiuions
Te ne resul o hese reorms was o provide aordable housing opions, includ-ing homeownership and aordably priced renal housing, o generaions o  American households, allowing hem o save and inves he bulk o heir incomeraher han spending his on sheler. I is no an exaggeraion o claim ha U.S.housing nance policy is he oundaion or he social mobiliy upon which heideal o he “American Dream” is based.Moreover, because o he srong regulaory oversigh o morgage lenders, his sys-em was exraordinarily sable, providing many decades o unprecedened sabiliy o invesors and borrowers alike—unil he ascendance o laissez-aire conservaiveeconomic ideology led o a seep decline in pruden supervision over he housingand nance markes, resuling in he 2000s housing bubble and consequen bus.

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