Contributing Editors

Jerome Lyle Rappaport

Jerome Lyle Rappaport
Founder and Board Member
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Edward Glaeser

Edward Glaeser
Professor of Economics at Harvard University
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Stephen P. Johnson

Stephen P. Johnson
Executive Director of Phyllis and Jerome Lyle Rappaport Foundation
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Greg Massing

Greg Massing
Executive Director for the Rappaport Center for Law and Public Service
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Alasdair Roberts

Alasdair Roberts
Professor of Law and Public Policy at Suffolk University Law School
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Joseph Curtatone

Joseph Curtatone
Mayor, City of Somerville
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Tim H. Davis

Tim H. Davis
Independent Research Consultant
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Scott Harshbarger

Scott Harshbarger
Senior Counsel, Proskauer Rose LLP
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Vivien Li

Vivien Li
Executive Director of The Boston Harbor Association
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Guest contributors

Monika Bandyopadhyay
Suffolk University Law Student

David Barron
Harvard Law School and former Deputy Counsel for the Office of Legal Counsel in the US Department of Justice

Linda Bilmes
Senior lecturer in public policy at the Harvard Kennedy School. Assistant Secretary of Commerce during the Clinton Administration.

Brandy H.M. Brooks
Director, Rudy Bruner Award for Urban Excellence, Bruner Foundation

Felicia Cote
Rappaport Fellow, Harvard Law School/Harvard Kennedy School.

Amanda Eden
Suffolk University Law School student

Sara Farnum
Student, Suffolk Univ. Law School

Kristin Faucette
Student at Suffolk University Law School

Benjamin Forman
Research Director, MassINC

Arthur Hardy-Doubleday
JD/MBA student at Suffolk University Law School and the Sawyer School of Business

Theodore Kalivas
Boston Green Blog, Dukakis Center for Urban & Regional Policy

David Linhart
Student, Boston University School of Law

Antoniya Owens
Research Analyst, Mathematica Policy Research, Inc.

Susan Prosnitz
Senior Advisor, TSA, Washington, DC

Ben Thomas
Boston Green Blog, Dukakis Center for Urban & Regional Policy

Matthew Todaro
Student at Boston College Law School

Alexander von Hoffman
Senior Researcher, Joint Center for Housing Studies

Brett Walker
Student, Boston College Law School

Margarita Warren
Student at Suffolk University Law School

Beyond Fannie and Freddie, a New Approach

Tuesday, February 15th, 2011
By Edward Glaeser

The report on Friday on “Reforming America’s Housing Finance Market” left me feeling downright giddy.

While the report is hardly a finished plan for Freddie Mac (the Federal Home Loan Mortgage Corporation) and Fannie Mae (the Federal National Mortgage Association), and going forward, countless opportunities will arise for everything to go awry, it is a very good start.

The report clearly explains the role that these entities, known as government-sponsored enterprises, or G.S.E.’s, played during the housing crisis, and it sensibly maps out a future with less pro-homeownership nonsense and a more responsible public sector.

The body of the report begins with an overview of the many public and private mistakes that gave us the Great Housing Convulsion of the first decade of this century, and its analysis of Fannie and Freddie during this period is satisfyingly scathing:

While Fannie Mae and Freddie Mac’s affordability goals were poorly designed and did not effectively serve their purposes (as detailed below), fundamental structural flaws and poor decision-making are the principal reasons these institutions failed.
The report then enumerates the original sins of the G.S.E.’s:

¶“Fannie Mae and Freddie Mac’s profit-maximizing structure undermined their public mission.”
¶“Fannie Mae and Freddie Mac’s perceived government backing conferred unfair advantages.”
¶“Fannie Mae and Freddie Mac’s capital standards were unfair and inadequate.”
¶“Fannie Mae and Freddie Mac’s regulator was structurally weak and ineffective.”

Indeed. Clearly seeing that the innate problems of the G.S.E.’s led directly to hundreds of billions of dollars in taxpayer losses is critical for avoiding the inadvertent recreation of these problems as we go forward. We must avoid two terrible pitfalls.

The leftward danger is that the government creates a new, unchecked public entity that insures mortgages in ever larger numbers to promote more housing affordability.

The rightward danger is that we privatize the G.S.E.’s and put ourselves right back where we were before the crisis, with profit-maximizing companies that can influence Congress and operate with an implicit government guarantee.

The Obama administration has been trying to find a solution to the G.S.E.’s for many months, and many people — including me — have been asked for advice. The report offers three options, and the best one, as is typical in such reports, stakes out the middle position.

The first option looks attractively laissez-faire. It’s described as a “privatized system of housing finance with the government insurance role limited” to the Federal Housing Administration, Agriculture Department and Department of Veterans Affairs assistance “for narrowly targeted groups of borrowers.”

That would mean the government would not officially insure the home mortgages of most middle-income Americans. The report notes that under this option, “It may be more difficult for many Americans to afford the traditional pre-payable, 30-year fixed-rate mortgage.” Maybe.

I’m more worried that “a related risk would exist if investors believe that the government would inevitably step in to save whatever private financial institutions or banks have become necessary to maintain the flow of mortgage credit.”

In other words, the government might end up insuring the mortgages anyway. That would be especially true if the mortgage insurance business were dominated by a few large companies, like a reprivatized Freddie and Fannie.

So if we went this route, we would have to make sure those entities were carved up so they were small enough to fail.

The third option takes option No. 1 and tacks on “catastrophic reinsurance behind significant private capital.” That may sound like a small, benign addition, but it isn’t. In this system, private insurers would provide a first line of insurance to mortgage securities, but if they failed, the public sector would step in.

This might be better than the old system, but if the government is sitting there with guarantees, the rest of the market has every incentive to hand off its exposure to the federal government.

As the report puts it, “If the oversight of the private mortgage guarantors is inadequate, or the pricing of the reinsurance too low, or recoupment of costs too politically difficult, then private actors in the market may take on excessive risk and the taxpayer could again bear the cost.”

Does recent history suggest that we should be confident about the government’s ability to oversee “private mortgage guarantors” and prevent private actors from taking on too much risk?

The middle option combines option No. 1 with “a guarantee mechanism to scale up during times of crisis.” I like this because its approach is “to price the guarantee fee at a sufficiently high level that it would only be competitive in the absence of private capital,” so that “it would thus only expand when needed, and that need would be dictated by the market.”

This approach would ensure that people could get 30-year fixed mortgages, just at a somewhat higher cost. It is the best path forward.

The G.S.E.’s can just gradually increase their insurance cost. The big challenge with designing this backstop is to give it a sufficiently tight mission and enough independence so that it doesn’t become a tool for housing advocates who want ever cheaper mortgages. We know where that can lead.

But my favorite parts of the report are when it says: “Our plan champions the belief that Americans should have choices in housing that make sense for them and for their families. This means rental options near good schools and good jobs.”

Later on, the report adds, “This does not mean our goal is for all Americans to be homeowners.”

For too long, our government has put homeownership on a pedestal and acted as if a suburban home is the only place to find the American dream. Our pro-homeownership policies have encouraged millions of Americans to make vast leveraged bets on housing prices — and many of those bets have led to foreclosures.

These policies implicitly push Americans from urban apartments to suburban homes, and that makes little economic or environmental sense.

The Republican Party retook the House with a promise to reduce government’s interference in private decision-making. I deeply hope it lives up to that promise and joins the fight against socially engineered homeownership.

In this area, as in so many others, Americans should be free to choose, without the public sector’s spending billions to push its own preferred living style. 


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