How to Privatize the Mortgage Market
October 27, 2010
Despite the Dodd-Frank financial reform enacted in July, the mortgage market remains frozen and effectively nationalized. Today 90 percent of the $14 trillion in outstanding residential mortgages is controlled by the Federal Housing Administration (FHA), the Department of Veterans Affairs, or Fannie Mae and Freddie Mac -- with the latter two under government conservatorship, says Dwight M. Jaffree, a finance and real estate teacher at the Haas School of Business at the University of California, Berkeley.
The solution? Privatize the mortgage market.
Fannie and Freddie have shown how government guarantees lead to dangerous risk-taking in which shareholders reap the profits but taxpayers pay for the losses. The goal today must be to allow home prices to stabilize at affordable levels and to allow mortgage rates and underwriting standards to reach safe, sustainable levels, says Jaffree.
The evidence is strong that private markets can provide the necessary supply of credit to sustain active housing markets.
- Virtually every European country has well-functioning private mortgage markets without government interventions of the Fannie or Freddie sort, or direct mortgage guarantees.
- Moreover, despite the worldwide financial crisis and economic downturn, private European mortgage markets today have delinquency and foreclosure rates that round to zero.
- European lenders, borrowers and taxpayers all recognize that high underwriting standards obviate the need for government bailouts.
A broader menu of choices would be one benefit of a privatized U.S. mortgage market, says Jaffree.
- European countries offer fixed and adjustable rates, with and without prepayment penalties, alternative amortization periods and so on.
- The 30-year, fixed-rate mortgage might well remain a favorite of U.S. lenders and borrowers, but only by competing in terms of costs and benefits on a level playing field with other mortgages.
- Probably the most divisive issue will concern "recourse," which allows lenders to take a homeowner's personal assets if he defaults on his loan; recourse in Europe lowers default rates and thereby mortgage rates.
Source: Dwight M. Jaffree, "How to Privatize the Mortgage Market," Wall Street Journal, October 25, 2010.
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