I spend plenty of time criticizing President Obama, so here’s one I think he may be getting right: Moving to wind down Fannie Mae and Freddie Mac. From the Associated Press:
The Obama administration wants to shrink the government’s role in the mortgage system — a proposal that would remake decades of federal policy aimed at getting Americans to buy homes and would probably make home loans more expensive across the board.
The Treasury Department rolled out a plan Friday to slowly dissolve Fannie Mae and Freddie Mac, the government-sponsored programs that bought up mortgages to encourage more lending and required bailouts during the 2008 financial crisis.
Exactly how far the government’s role in mortgages would be reduced was left to Congress to decide, but all three options the administration presented would create a housing finance system that relies far more on private money.
This is potentially great news if you believe, as I do, that Fan and Fred played a critical role in inflating the housing bubble to the point that it threatened the entire financial system. Their bailouts, the AP reports, are currently projected to cost taxpayers between $150 billion and $260 billion.
The Wall Street Journal’s editorialists have been writing presciently about the perils of these quasi-governmental behemoths for two decades, so I’ll trust them when they say one of the options is far superior to the other two:
Door No. 1 is the best of the lot by our lights. Under this option, federal guarantees would be limited to Federal Housing Administration (FHA) loans for lower-income buyers and VA assistance for veterans and farm programs — each a narrowly targeted market segment. A Treasury official says this would reduce the taxpayer backstop over time to about 10% to 15% of the mortgage market [down from the current level of 92%].
The Administration puts the case for federal withdrawal from the broader housing market in compelling terms: “The strength of this option is that it would minimize distortions in capital allocation across sectors, reduce moral hazard in mortgage lending and drastically reduce direct taxpayer exposure to private lenders’ losses.” Bravo.
Treasury points to other benefits: “With less incentive to invest in housing, more capital will flow into other areas of the economy, potentially leading to more long-run economic growth and reducing the inflationary pressure on housing assets. Risk throughout the system may also be reduced, as private actors will not be as inclined to take on excessive risk without the assurance of a government guarantee behind them. And finally, direct taxpayer risk exposure to private losses in the mortgage market would be limited to the loans guaranteed by FHA and other narrowly targeted government loan programs: no longer would taxpayers be at direct risk for guarantees covering most of the nation’s mortgages.”
This option would at least put Washington on a possible road to ending all federal guarantees related to housing, with Congress only subsidizing housing through its annual spending rather than sustaining two going, and ever-growing, concerns like Fannie and Freddie.
The downside? “The Administration,” the WSJ writes, “says this option could reduce access to credit for some home buyers, and that it would leave the government without the tools to intervene in a future crisis.” But that isn’t necessarily the case:
As for the credit point, other countries have high rates of home ownership with far less government support. If the government stands aside, it would open the way for alternative forms of finance, such as covered bonds, that now can’t compete in the U.S. because of government favoritism for the 30-year mortgage model. This would open options for borrowers by increasing the diversity of financing.
As for a future crisis, government intervention is less likely to be needed if the market isn’t distorted by government subsidies in the first place.
The other two options both leave the door wide open for re-expansion or for political tinkering to benefit favored groups.
The Obama administration has done a good thing in putting the end of Fan and Fred on the table. Now it’ll be incumbent on the president to work with Congress to implement whichever option it deems best.
– By Kyle Wingfield
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