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The hard part is fixing the balance between the public and private sectors. Representative Scott Garrett (R-N.J.), who chairs the House subcommittee that oversees the mortgage-buying giants, this year introduced a series of bills to wind Fannie and Freddie down over the long term and vowed in March to “return our housing finance system to the private marketplace.”
The free-market purist position would, for better or worse, dramatically change American housing finance. Investors would require considerably higher yields to buy mortgage-backed securities that lacked a government guarantee, which would mean higher mortgage rates or much tighter underwriting standards, says Kenneth Snowden of the University of North Carolina at Greensboro.
Without government loan guarantees, the U.S. would probably come to look more like Britain, where only adjustable-rate loans are available. British homeownership rates are nearly 70 percent. But British borrowers bear all the risk of fluctuating interest rates—“a risk that they are not particularly well-suited to bear and cannot easily hedge,” economists Wachter and Green wrote.
Some conservatives such as Alex J. Pollock of the American Enterprise Institute say the 30-year fixed-rate loan would survive just fine without a government guarantee, albeit perhaps with a higher interest rate. They argue that the benefits from the guarantee are tiny compared with the predictable cost—Pollock promises “yet another massive bailout in the future.” The 30-year loan should be at most a niche product because “it imposes costs on borrowers, on the mortgage distribution system, and on investors,” argues Lea, the San Diego State University economist.
The counterargument: There’s nothing like a 30-year fixed-rate loan for predictable household budgeting and peace of mind. The loan “worked for more than 40 years” and still can, Ranieri, who now invests on his own as head of Ranieri Partners Management, wrote in a white paper earlier this year called “Plan B.”
Even if the 30-year fixed loan dies, turning the clock back to the 1920s and fully reprivatizing housing is an unrealistic objective for one simple reason: The American people won’t stand for it. Americans want to be able to borrow on good terms even when private capital flees, as it has in the current bust. When push comes to shove, the government will never let the entire lending business fail, so the feds might as well make their support explicit and demand some accountability in return. “As distasteful as bailouts are, we as a society are simply too scared of the potential consequences of not bailing out the system to find out what would happen,” Adam J. Levitin, a Georgetown University Law Center professor, wrote in congressional testimony in September.
The most innovative ideas for housing finance can’t be categorized as left or right. Figures as diverse as liberal investor George Soros and the GOP’s Scott Garrett suggest that the U.S. adopt some variant of European covered bonds, which are safer than U.S. mortgage-backed securities. The Danish mortgage system dates back to the reconstruction of Copenhagen after the Great Fire of 1795. Unlike American banks that securitize their loans, Danish mortgage lenders retain the full risk of default, giving them an incentive to underwrite cautiously. The loans are packaged into covered bonds. In more than 200 years, there has never been a default on one of these bonds. And though Denmark’s housing bubble was even bigger than the U.S.’s, its foreclosure rate has remained low. One downside is that the system is best suited to long-term mortgages. The system is under strain now that 44 percent of Danish loans are adjustable-rate mortgages.
Want more ideas? Andrew Whinston, a University of Texas at Austin professor of management science and information systems, says securitization could be fixed by making contracts “dynamic” instead of “static.” To make sure lenders have skin in the game, they wouldn’t get paid all at once. Ralph Y. Liu, a Wharton MBA who is managing director of the PeoplesAlly Foundation, promotes a hybrid form of homeownership in which a renter contributes 10 percent of the purchase price in return for a tenth of any appreciation (or depreciation) in the property’s value.
