Privatizing the U.S. mortgage market and eliminating Fannie Mae and Freddie Mac are the best ways to work toward stabilizing the U.S. housing finance system, says Haas School Professor Dwight Jaffee. “Fannie and Freddie must have a graceful burial as the first step toward creating a private and efficient U.S. mortgage market.”
Jaffee has studied mortgage trends for more than 40 years. He recently spoke before the Financial Crisis Inquiry Commission and the President’s Economic Recovery Advisory Board — two blue-ribbon panels investigating the subprime crisis–to present his policy proposals and outline how to make the transition from government-subsidized lending to a private mortgage market. Jaffee is a professor of finance and real estate and co-chair of the Fisher Center for Real Estate and Urban Economics at Haas.
Currently, the private sector is crowded out and cannot compete with government-sponsored enterprises (GSEs), such as Fannie Mae and Freddie Mac, which offer government guarantees to private investors who supply capital for mortgage-backed securities, Jaffee says.
While Jaffee strongly endorses government programs to aid first-time and low-income home buyers, he says those subsidies should be handled by the Department of Housing and Urban Development (HUD), not GSEs.
“The way we’ve been subsidizing homeownership in this country is ludicrous,” says Jaffee. “HUD’s budget has been about $35 billion annually while Fannie and Freddie have issued about $5.5 trillion of government guaranteed obligations. There is no reason why we should continue to subsidize people who already own homes.”
1) Reducing the conforming loan limit steadily by 10 percent annually to reach zero over ten years. For example, for those areas where the limit is currently $417,000, this would mean an annual decrease of $41,700. For those areas where the limit is currently $938,000, this would mean an annual decrease of $93,000.
Says Jaffee: “A key feature is that you announce it ahead of time. Every January 1, the private market knows what new areas of the market are now open to private competitors. Over time, Fannie and Freddie disappear because they are not allowed to purchase mortgages that exceed the conforming limit."
2) The creation of a government facility within HUD that would be responsible for emergency support of the mortgage market if the private mortgage markets were to falter in the future due to another financial or economic crisis.
Says Jaffee: “This facility would have the power to provide government guarantees for mortgages and thus could provide emergency support for the mortgage market similar to the way Federal Emergency Management Agency (FEMA) provides emergency support following natural disasters."
This facility is also Jaffee’s answer to alternative proposals that would provide some type of government guarantee for the middle of the market. He points out that if middle-income borrowers are not well served by the private market as the GSEs disappear, then the facility could be activated to provide market support until the market failure is fixed. When operating in this mode, the government facility would charge borrowers a guarantee fee. Eventually, he says the fee should be increased enough to allow the private market to compete again.
Jaffee predicts the move toward mortgage privatization will cause interest rates to rise roughly one-quarter to one percent, which in turn would have a dampening effect on future housing price increases. He argues Americans are foolish to think that houses will appreciate any faster than other types of investments. “It’s more like a car,” explains Jaffee. “People don’t buy a car to get rich on it. It’s the same with housing. You should buy it primarily to provide shelter.”
Overall, Jaffee argues that a private market offers the housing system something the government cannot: incentive to innovate and create fresh approaches to the traditional mortgage contract, and confidence that taxpayers will not again be called on to bailout out mortgage market participants.