Until 2008, few people complained that government largely controls the secondary mortgage market. After all, Uncle Sam helped and still helps subsidize mortgages across the board, fostering home ownership. How apple pie.
Yet it’s also a lot like pork pie, another irresistible American tradition. Though plenty of folks wouldn’t want government prying into their home lives, they seem content to have Uncle Sam dictating mortgage design, scale and cost.
Fannie Mae and Freddie Mac were sponsored decades ago by the federal government. They created and dominated the secondary mortgage market, buying mortgages from originating lenders of all sorts on their terms, then repackaging the homeowners’ promises to repay the loans into securities sold to investors.
Homeowners of all income levels liked getting apparently-cheaper loans with less money down and reduced standards. Realtors and home builders liked selling more homes. Homeowners with no mortgages benefited from home prices floating higher. Politicians acquiesced to satisfy diverse constituencies under the bully banner of the American dream of an owned home for all -- even those who couldn’t afford to own the particular homes (including McMansions) they were buying.
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Investors didn’t pay much attention to what was backing up the mortgage securities, assuming that the federal government would back up Fannie and Freddie to make good on the underlying promises of homeowners to repay, even if individual homeowners defaulted on their mortgages en masse.
When legions of homeowners eventually did default, and Fannie and Freddie went broke, the government’s implicit promise to repay was made explicit. In part to avoid a bigger housing crash and wider financial meltdowns, the feds stepped in to rescue mortgage investors with about $238 billion in direct subsidies and plenty more splashed around the banking system. Little went to rescue defaulting homeowners themselves, but you might say that many of them already had gotten a generous helping of pork to the extent they got dubious loans attributable to governmental intervention.
Now, five years later, with the financial system stabilized, home prices firming and mortgage defaults lessening, Congress and the president have decided that it’s time to fix the secondary mortgage market, which has now become almost wholly a government-controlled fun house. Eighty-seven percent of mortgages or more are now sold to and through Uncle Sam.
Last week in Phoenix, President Obama laudably outlined his relevant goals. “I think our housing system should operate where there’s a limited government role,” he said, “and private lending should be the backbone of the housing market.”
Easier said than done.
Republican Sen. Bob Corker of Tennessee and Democratic Sen. Mark Warner of Virginia are sponsoring a bill that Obama has endorsed. Unfortunately, it probably won’t achieve those goals, according to mortgage experts like Karen Shaw Petrou, Ed Pinto and Peter Wallison.
Even if we traded Fannie and Freddie for a new Federal Mortgage Insurance Corporation as envisioned by the Corker/Warner bill, we’d still have many of the same political pressure points by which government could force lenders to accept terms that would otherwise not independently be considered responsible lending.
For instance, the bill would encourage lending at only 5 percent down, and would require lenders to take on dangerous bets on long-term interest rates by offering 30-year fixed-rate mortgages. The bill would put politicians in charge of pricing and setting evolving terms for the so-called “insurance.” Through that device alone, federal politicians could still largely control the mortgage business.
Although the bill would put some private investor money at risk of loss before 90 percent of the losses hit government, private risks would probably be priced into the value of the securities. That means investors would probably do nothing to ensure better lending decisions.
Better alternatives exist. One sensible proposal is to require higher down payments to keep borrowers riveted on avoiding default despite fluctuations. Meanwhile, lenders should not be required to bet on long-term interest rate predictions. Low-income borrowers, the group most deserving of subsidies, could still be assisted through the Federal Housing Administration.
Sound finance is not pork politics. The mortgage “market” needs to become a real market.
David Oedel teaches law at Mercer University.