Commentary

How Mortgage Market Should Be Fixed

Now onto actually addressing one of the causes of the financial crisis: our deeply flawed housing finance system.

For a White House conference set for next week on housing finance to be truly effective, we must ask ourselves some basic questions about what our mortgage system should do and how it should operate. We must also ensure that the rescue of Fannie Mae and Freddie Mac — one that will likely exceed the cost to the taxpayer of every bank failure in American history combined — will never be repeated.

The central flaw in our current system is that the gains from risk-taking are divorced from losses. All too often, lenders, homeowners and the real estate industry reap the rewards, while the taxpayer is left holding the bag. This needs to end.

We should also recognize that homeowners and taxpayers are often the same people. Policies that take a dollar out of your left pocket just to put it back in your right pocket do not provide a real benefit. Of course homeowners would be lucky, as taxpayers, to actually get a dollar back for every dollar they put in. A more accurate description would be paying a dollar to gain maybe 50 cents.

Despite the frequent recurrence of housing booms and busts, our mortgage finance system is not built to withstand the busts.”

In addition to aligning the costs and benefits within our mortgage finance system, those costs and benefits should be both transparent and credible. Implicit subsidies and contingent liabilities should be a thing of the past.

The era of politicians winking and nodding about the “private” status of Fannie Mae and Freddie Mac should be no more. Any subsidies should be on-budget, as well as accurately and fairly estimated. This means no more assuming that house prices only go up or that the business cycle is dead.

Despite the frequent recurrence of housing booms and busts, our mortgage finance system is not built to withstand the busts. After the losses of the savings and loan crisis and now the historic losses of Fannie Mae and Freddie Mac, any regulatory system for housing finance should assume there will be another housing bust in the future.

In making our system more resistant to crises, we should avoid policies that concentrate either credit or interest rate risk into a small number of entities. As bad as the savings and loan crisis was, there was no one company whose failure threatened our economy. The same cannot be said for Fannie Mae and Freddie Mac.

Firms will, and should, sometimes fail. Our mortgage finance system should be able to withstand the failure of any one firm. The best way to accomplish this is to not concentrate all the risk in one place.

Our current mortgage policies encourage an excess degree of leverage, both on the part of homeowners and financial institutions. Ownership and debt are not synonymous. Absent the many subsidies for mortgage debt, families would have more equity in their homes, allowing them a greater cushion when house prices fall.

To the extent that we subsidize homeownership — something that in itself should be debated — those subsidies should be designed so that their benefits go largely to the homeowner, and exclusively to families who would not be homeowners otherwise. Too much of the current subsidies simply end up in the pockets of the real estate and mortgage industries.

Much of the current subsidies also do little more than run up house prices, without actually improving affordability. Any policy that increases the price of one of life’s basic necessities — shelter — is a policy we should question if not outright reject.

Perhaps most importantly, our mortgage finance system must be better insulated from politics. Booms are always popular when they occur, and the natural instinct of politicians is to reinforce the popular. The less politics pervades mortgage finance, the less likely government is to add fuel to the fire during the next housing boom.

On a narrower level, the mortgage finance system has been repeatedly used by government over the last few decades as an avenue for redistributing wealth. To the extent that government should redistribute income, it should be carried out directly and transparently via the welfare system. The sole purpose of mortgage finance should be to finance mortgages, not to solve every social problem under the sun.

We have a rare opportunity in public policy: correcting a major flaw in our economy. While there is widespread agreement that our mortgage finance system is broken, we risk simply applying a few Band-Aids if we do not begin a serious and thoughtful conversation about what that system should achieve. Before we worry about the politics, we should decide upon the principles.

Mark Calabria is director of financial regulation studies at the Cato Institute in Washington, D.C.