NCPA - National Center for Policy Analysis

Using Private Market Incentives to Reform the U.S. Mortgage Market

March 9, 2011

Government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac are unsustainable -- the expected costs they create for U.S. taxpayers far exceed their expected benefits.  The question is then how to reorganize the U.S. mortgage market in the absence of GSEs, say Dwight Jaffee, a professor at the Haas School of Business, University of California at Berkeley.

Jaffee's paper develops and evaluates a proposal to reform the U.S. mortgage system on private market principles and without any form of government-sponsored enterprises.  The proposal is implemented through the simple process of reducing the GSE conforming loan limit by, say, $100,000 annually, with the result that the GSEs will cease to operate after about seven years.  The primary issue facing the proposal is very direct: will a private market provide the stability and access to mortgage credit required by U.S. homebuyers? 

  • Mortgage origination activity would be unchanged from the current system, since originations are already only carried out by private market entities.
  • Mortgage investing would similarly continue to be dominated by the two largest existing holders, depository institutions and capital market investors.
  • Depository institutions will continue to hold a significant amount of whole mortgages in their portfolios, and the capital market investor portfolios will continue to be dominated by mortgage-backed securities.
  • It is also likely that covered bonds will play a more important role in the U.S. market, as depository institutions fund some of their mortgage portfolios by issuing secured debt to capital market investors.
  • In this fashion, the market should readily absorb the 12 percent market share vacated by the departing GSEs.

Source: Dwight Jaffee, "Reforming the U.S. Mortgage Market Through Private Market Incentives," Mercatus Center, March 2011.

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