Role of the Government in Residential Mortgage Markets
October 26, 2011
David Scharfstein, Harvard University and NBER, and Adi Sunderam, Harvard University
Scharfstein and Sunderam analyze the two leading types of proposals for reform of the housing finance system: broad-based, explicit, priced government guarantees of mortgage-backed securities (MBS); and privatization. Both proposals have drawbacks. During normal times, properly-priced guarantees would have little effect on mortgage interest rates relative to unguaranteed mortgage credit and would expose taxpayers to moral-hazard risk with little benefit. Privatization reduces, but does not eliminate, the government's exposure to mortgage credit risk. It also leaves the economy and financial system exposed to destabilizing boom-and-bust cycles in mortgage credit. Based on their analysis, they argue that the main goal of housing finance reform should be financial stability, not the reduction of mortgage interest rates. To this end, they propose that the private market should be the main supplier of mortgage credit, but that it should be carefully regulated. This will require new approaches to regulating mortgage securitization. Moreover, they argue that while government guarantees of MBS have little value in normal times, they can be valuable in periods of significant stress to the financial system, such as in the recent financial crisis. Thus, they propose the creation of a government-owned corporation that would play the role of "guarantor-of-last-resort" of newly-issued (not legacy) MBS during periods of crisis.
Valentin Bolotnyy, Federal Reserve Board of Governors
The U.S. mortgage crisis that began in 2007 has generated questions about the role of Fannie Mae and Freddie Mac, the government sponsored enterprises (GSEs). Some have claimed that the Affordable Housing Goals (AHGs) introduced by Congress through the GSE Act of 1992, and the resulting purchases of single-family mortgages that the GSEs made to meet those goals, drove lending to high-risk borrowers. Bolotnyy measures the effect of one of those programs --, the Underserved Areas Goal (UAG --, on the number of single-family mortgages purchased by the GSEs in targeted census tracts from 1996 to 2002. Focusing also on tracts that became UAG-eligible in 2005-6, when the Department of Housing and Urban Development began to determine eligibility using the 2000 Census, he measures the effect of the UAG on GSE purchases during peak years for the subprime mortgage market. The first approach reveals a statistically insignificant UAG effect of 0 to 3 percent. The second approach measures a significant 2.5 to 5 percent effect. The overall results suggest a small UAG effect and challenge the view that the AHGs caused the GSEs to supply substantially more credit to high-risk borrowers than they otherwise would have supplied. In turn, this suggests that the AHGs by themselves did not spark the subprime lending boom of 2002-6.
Dwight Jaffee and John M. Quigley, University of California at Berkeley
Jaffee and Quigley analyze options for reforming the U.S. housing finance system in view of the failure of Fannie Mae and Freddie Mac as government sponsored enterprises (GSEs). The options considered include: GSE reform; a range of possible new governmental mortgage guarantee plans; and greater reliance on private mortgage markets. They also pose the larger question of the proper role for government in the U.S. housing and mortgage markets. After reviewing the history of the GSEs and their contributions to the operation of U.S. housing and mortgage markets, including the actions that led to their failure in conjunction with the recent mortgage market crisis, they consider: options proposed in a 2011 U.S. Treasury White Paper; plans for new government mortgage guarantees from various researchers and organizations; and evidence from Western European countries on the efficacy of private mortgage markets.
Patricia Mosser, Joseph Tracy, Tony Dechario, James Vickery, and Joshua Wright, Federal Reserve Bank of New York
Dechario, Mosser, Tracy, Vickery, and Wright describe a set of six design principles for the reorganization of the U.S. housing finance system and apply them to one model for replacing Fannie Mae and Freddie Mac that so far has received frequent mention but little sustained analysis: the lender cooperative utility. They discuss the pros and cons of such a model and propose a method for organizing participation in a mutual loss pool and an explicit, priced government insurance mechanism. They also discuss how these principles and this model are consistent with preserving the "to-be-announced," or TBA, market - particularly if the fixed-rate mortgage remains a focus of public policy.