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Reason
Foundation...
Ten Arguments Against
a Government Guarantee for Housing Finance
Why there should not be a government role—explicit or implicit—in
guaranteeing housing finance
By Anthony Randazzo
February 4, 2011
There is a growing belief among mortgage investors, industry groups and
some policymakers in Washington that some type of explicit government
guarantees for mortgage lending will be necessary to undergird a new
housing finance system in America. Yet whether by the sale of insurance
on mortgage-backed securities or a public utility model replacing
Fannie Mae and Freddie Mac with new government-sponsored enterprises,
this would be a tragic mistake, repeating the errors of history, and
putting taxpayers and the housing industry itself at risk. This policy
summary offers ten arguments for why there should be no government
role—explicit or implicit—in guaranteeing housing finance.
1. Government guarantees always underprice risk. All federal guarantees
underprice risk in order to provide a subsidy for lending. That is
their purpose. And taxpayers will be exposed to losses in the future,
as those risks materialize.
2. Guarantees eventually create instability. Guarantees failed to
prevent the savings-and-loan crisis and subprime crisis. In fact, they
contributed to the cause of both by distorting the market.
3. Guarantees inflate housing prices by distorting the allocation of
capital investments. The artificially increased capital flow will make
mortgages cheaper, boosting demand for housing and pushing up prices,
ultimately creating another bubble.
4. Guarantees degrade underwriting standards over time. Historically, a
primary justification for guarantees has been to increase the
availability of finance to politically important groups with higher
credit risks. It is inevitable that this will continue to happen,
requiring the government to lower underwriting standards, and resulting
in more risky mortgages.
5. Guarantees are not necessary to ensure capitalization of the housing
market. As has begun already, the jumbo market will evolve and
practically any credit-worthy potential homebuyer will be able to get a
mortgage in a fully private system.
6. Guarantees are not necessary for homeownership growth. Other nations
have substantially higher homeownership rates in spite of having far
less government interference in their housing markets.
7. Guarantees drive mortgage investment in unsafe markets. As long as
there is a government guarantee covering financial institutions,
investors and lenders will look to the government’s credit, not the
credit of institutions and loan applicants themselves.
8. Guarantees are not necessary to preserve the “To Be Announced”
market for selling mortgage-backed securities. If needed, a TBA market
could easily develop with originators hedging against any short-term
interest-rate risks in the private sector.
9. Guarantees are not needed to prevent “vicious circles” that drive
down prices. Mild price movements in the housing market are necessary
to keep balance in the market. Keeping prices artificially high reduces
housing demand and prolongs recovery. The most common threat of default
as prices decline is from borrowers who have little equity in their
homes—because they borrowed at high loan-to-value ratios—seeing the
value of their homes drop below what they owe. Guarantees support these
high-credit-risk borrowers.
10. Even a limited guarantee on just mortgage-backed securities
targeted at protecting against the tail risk will slowly distort credit
allocation and investment standards, ultimately destabilizing the
market and forcing the need to rely on the guarantee.
Read the story at Reason
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