Your Mortgage, Their Rent
August 23, 2013
When firms compete for government subsidies and regulatory advantages, economists call it "rent-seeking." As Washington considers how to replace Freddie Mac and Fannie Mae in the mortgage market, we can expect the policy process to be dominated by rent-seekers. That is how it has been for generations, says Arnold Kling, a member of the Mercatus Center's Financial Markets Working Group.
Who will win the battle to get the most favorable subsidies and regulations?
- At this point, all signs point to victory by two of the biggest culprits in the mortgage crisis -- the mortgage bankers (firms that originate loans to distribute, not to hold) and the Wall Street investment banks.
- Both depend on securitization if they are to participate in the mortgage lending process.
- However, securitization has only been able to compete with traditional bank lending when securities are backed by guarantees from the taxpayers and when bank capital requirements punish banks that hold their own loans.
From the end of World War II until the late 1980s, mortgage lending in the United States was dominated by the savings and loan industry (S&L). The S&Ls, particularly the large California thrifts, were formidable players in the rent-seeking game. Interest rates on consumer deposits were regulated and the California thrifts rigged the system by making sure that in competing for those deposits, they were permitted to pay slightly higher interest rates than banks.
Congress chartered Freddie Mac in 1970, which created a "secondary market" in mortgages, allowing California thrifts to sell packages of mortgages as securities to investors outside of the state. The California S&Ls could then use these outside funds to expand their in-state mortgage lending.
- The 1990s saw Freddie and Fannie come to dominate the mortgage market. They also became dominant figures in Washington by expertly playing the rent-seeking game.
- They and their friends on Wall Street obtained favorable tax treatment for esoteric mortgage security instruments.
Today, the housing finance reforms that have the most bipartisan support appear to do exactly what Wall Street wants. They create a new government agency to guarantee mortgage securities. They do nothing about the perverse capital requirements that penalize banks that originate safe loans while rewarding banks that hold securities backed by dodgy loans. They ensure that mortgage securitization, which has never demonstrated an ability to compete on a level playing field in the market, will continue to dominate the American mortgage market. Whenever this system suffers its next crisis, taxpayers will be delivering the bailout. The mortgage bankers and Wall Street firms win. You lose.
Source: Arnold Kling, "Your Mortgage, Their Rent," American Enterprise Institute, August 21, 2013.
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