In a recent American.com essay, Peter Wallison asserts that it is “completely frivolous” to believe that the government is incapable of resisting the urge to bail out the housing market. But history is not so kind to this assertion. Congress has taken many steps to foster homeownership and it seems far from frivolous to envision that Congress would act again in the future if mortgage credit dried up for American families. One can similarly imagine an intervention taking place if the secondary market in mortgage-backed securities locked up, since this in turn would likely lead to a lack of credit for new mortgages. After all, the Federal Reserve and Treasury Departments intervened in the fall of 2008 to stabilize money market mutual funds, which then consisted of not quite $4 trillion of assets. Housing-related securities are $10 trillion out of around $53 trillion in U.S. debt. While one can hope that a future administration and Congress in the midst of a financial crisis would avoid particular interventions, Wallison rests on just this—hope.
Wallison criticizes my proposal for housing finance reform that includes an explicit secondary government backstop on conforming mortgage-backed securities. He points out that the government will charge too little for providing the insurance. Oddly, Wallison writes as if my proposal does not recognize this. But a key facet of my proposal is to allow entry by new firms that securitize conforming MBS precisely because the government will inevitably underprice the guarantee. The competition from these entrants will help ensure that the implicit subsidy of underpriced insurance goes to homebuyers in the form of lower interest rates rather than being kept by GSE shareholders and management as in the previous system. Wallison does not have to agree with this proposed response to the inevitable government underpricing of insurance, but his criticism has a disingenuous flavor in pretending that it was not made.
My view is that the government will intervene in housing in the future and will underprice insurance today. As the saying goes, these are not problems to be solved, but instead facts of life that must be dealt with. My proposal for housing finance reform does so by ensuring that there is considerable private capital ahead of a secondary guarantee, taxpayers are compensated for taking on risk, and private market competition directs the benefits of the inevitable government subsidy to homeowners. Moreover, allowing for entry by new firms will eventually result in a housing finance system in which firms are no longer too big to fail.
The alternative espoused by Wallison would involve a system that is notionally private but in which the government guarantee is latent and uncompensated. Moreover, given that there is little prospect for the fully private alternative to ever come into being, holding out for it in fact leaves Fannie and Freddie in government hands—and the longer this persists, the more likely they will stay there forever. Waiting for a supposedly perfect but unattainable housing finance reform could instead leave us permanently with the worse alternative of a government-run housing finance system in which there is no private capital other than downpayments and none of the benefits of private sector competition and innovation.
Phillip Swagel is a professor at the University of Maryland’s School of Public Policy and a visiting scholar at the American Enterprise Institute.