Arnold Kling, on a roll

Here goes:

Old consensus: we need Freddie and Fannie in order to make housing "affordable."

New consensus: we need them in order to "prevent further house price delclines," in other words, to make housing less affordable.

It's the Goldilocks theory of home mortgage intervention.  Most of all, I am curious what is the underlying theory why few private investors would not, without the mortgage agencies, fund mortgages at the right price.  I would gladly write a series of blog posts examining those theories, as many of those same investors buy riskier assets, such as some equities.  Or is it simply an attempt to hold a finger in the dike?

Our either real or supposed inability to do away with the mortgage agencies over a five-year time horizon is one of the major reasons to be a pessimist about the American economy today.  None of the underlying theories about these agencies, and why they are needed, are very good news for any of us.  And that is perhaps why those theories are not articulated very often.


My worldview pre-crisis: Hold off on buying a home until I can afford a 20% down payment and a fixed mortgage. Don't be irresponsible. Those who are pushing up the price of housing by doing irresponsible things will be hurting once the bubble pops. Prices will fall, and between that and my savings in the interim, I will have money to make a home purchase.

My worldview post-crisis: When everyone else is doing it, act irresponsibly. As long as you make the same mistakes as everyone else, you will be saved. It's the little guy's only way to get in on "too big to fail." My plan backfired. I still can't afford a home because the government has propped up prices. I've been paying rent for 5 years instead of earning any equity. Worst of all it's my taxes and my future taxes that are paying for this little trick.

I think we need to step back and look at why they existed in the first place. Is there a role for a government agency that provides non-predatory interest rates on homes for low income buyers? Absolutely. Is there a role for the government in the mortgage markets past that? I can't see that.

"Is there a role for a government agency that provides non-predatory interest rates on homes for low income buyers? Absolutely."

Wait, what? Given their relative lack of income, stability, experience with maintaining a home, poorer job prospects, etc, why do I want to encourage them to buy with "non-predatory" rates? You say predatory, I say priced-correctly-for-risk. Let's call the whole thing off.

"Wider acceprtance of the adjustable rate mortgage could be an answer. "

The 30 year fixed rate mortgage probably would not exist without F&F for reassons T. Shaw lays out. It's just a very risky, mismatched product for most investors. Adjustable rates would be one option. Another option (I think Arnold has mentioned this too) is a five year, non amortizing fixed mortgage with a balloon payment. The short term strucuture protects investors from interest rate moves. The homeowner would have to roll over the mortgage every five years at prevailing interest rates, and hopefully be able to pay off a little principal each time. If the value of the home drops, he would have to put up more cash and/or accept a higher interest rate.

Basically, the past and current subsidized market have shifted risk (both price and interest rate) away from homeowners that will eventually have to be shouldered by them again.

The important thing is liquidate the 20M homes in foreclosure, start there. Get the Fed to state clearly it will not acquire MBS, and then push banks to mark to market on foreclosures. And liquidate the homes to buyers with 40% down (the equity % we have historically held against property values.

To make the pill less bitter for Dems, use the MERS violation to keep the displaced from having their credit score dinged, so when they have a real down payment, they can again buy a cheaper house.

Once we have a reset on home prices, its a lot easier to talk about private underwriting. Certainly cheaper rents, and a mobile workforce benefits those at the bottom more than the false god of home ownership.

Morgan Warstler:

Who has 40%?

I love the comment that goes
"The government then allowed"
and proceeds to claim it is all the governments fault as if the private lenders had no free will to do otherwise.

Another option (I think Arnold has mentioned this too) is a five year, non amortizing fixed mortgage with a balloon payment.

My understanding is that Fannie was created in the 1930's to organize a secondary market for mortgages. This would allow banks to sell their mortgages and create new ones. Evidently, it also allowed 30 year mortgages to become the norm. Prior to Fannie 5 year balloon notes were the norm and during the depression these notes were not renewed and people lost their homes.

Looking back on 70+ years of history, this system appears to have worked fairly well until recently, at least until it was privatized.

So do you really want to throw the baby out with the bath water? Do you really want to go back to 5 year balloon notes?

If you get rid of Fannie, will the private market provide a similar secondary market for mortgages? The private market did not provide that in the 20s and 30s.

Readers who are interested in a factual, neutral review of the issues may wish to consult Theresa DiVenti's summary here:

rs, Who said F&F caused the housing crisis? Strawman?

Tim wrote:

I think we need to step back and look at why they existed in the first place. Is there a role for a government agency that provides non-predatory interest rates on homes for low income buyers? Absolutely. Is there a role for the government in the mortgage markets past that? I can't see that.

Why not rather rent to own public housing.

Clarification: F&F did not take their current form through CRA in the late 1970s.

F&F took their current form in 1989 and 1991 with the passage of FIREA and FHEFSSA. Their regulator took its current form in 2008. As for FHEFSSA in the early 90s, there was a transition period for implementation of low and moderate income housing goals (which were in FHEFSSA but for some reason people think were in CRA - I think people are conflating GSEs and banks), which went into effect in the mid-1990s (and were subsequently raised at every opportunity by HUD secretaries of both parties).

Quite a few Fed apologists have pointed out that the housing bubble (as measured by the difference between house prices and rents, and house prices and construction costs) began in the late 1990s, not in the early 2000s. The Fed apologists are trying to deflect the charge that the Fed's low interest rate policies in the early 2000s created the housing bubble.

To sum up. S&L Crisis leads to revamping Freddie MAC to match Fannie in the early 90s, FHEFSSA creates low and moderate income housing goals for F&F that go into effect in the mid-1990s, by some measures a housing bubble begins in the late 1990s and soars in the early 2000s. Bubble bursts and F&F become insolvent in late 2000s.

I do not personally believe that the F&F housing goals created the housing bubble. However, it does fit an ex post argument pretty well. This is completely distinct from any CRA discussion.

@Mark, Thank you for the reference to the publication describing the options that appeared missing in the discussion thus far.

For the audience, here are the options posed in the document Mark cited:

"The potential policy options for the GSEs range widely. Six possible models include (1) returning the companies to their previous status as GSEs with the paired interests of maximizing returns for private shareholders and pursuing public policy homeownership goals; (2) incorporating the GSEs’ functions into a federal agency; (3) creating a public utility model in which the government regulates the GSEs’ profit margin, sets guarantee fees, and provides explicit backing for GSE commitments; (4) converting the GSEs’ corporate purpose to being providers of insurance for covered bonds; (5) dissolving Fannie Mae and Freddie Mac into many smaller companies; and (6) gradually winding down the GSEs’ operations and liquidating their assets.13 Within the context of each of these models, the public purpose objectives of the GSEs need to be examined and evaluated.

If the GSEs were to be fully privatized shareholder-owned companies, they would no longer have their public purpose objectives. It is unlikely that fully privatized companies would provide the desired social benefits. During stressful economic periods, such companies generally withdraw from mortgage markets or fail, providing little or no support to mortgage markets. Earlier discussions supporting fully privatizing Fannie Mae and Freddie Mac were predicated on the conditions that the GSEs were stable, well managed, and economically viable institutions. It is unclear at what point in the future these conditions will again apply."

@Andrew, In response to your question, the policy items the GSEs provide is listed in the sentence that followed the one you quoted: "During stressful economic periods, such companies generally withdraw from mortgage markets or fail, providing little or no support to mortgage markets." The implication being that GSE or a guaranteed option would remain in the market, providing liquidity for real estate transactions.

As between a house or a government bond, I would think a house is a less liquid asset, so, if, during a recession, real estate transactions lock up because a financial lender could not obtain additional financing for real estate, I guess we would just have to live with it. The question is: is it avoidable injury or are there better options in absorbing or spreading risks that are less costly (both privately and publicly). We might be willing to live with a lock up of the real estate market; that might be desirable in terms of disciplining buyers; but, on the other hand, there may be a better way to mitigate the risks and external costs.

A possible reason the aggregate debt to housing stock ratio was .4 WAS nearly 50% of homeowners had no mortgage debt. Not sure what the number is now. LTV of 80% (20% owner equity) was the norm and debt to income was about 30%. Problems was appraisal (many fraudulent of fairy tale value) values were used and sound financial analysis and credit underwriting werte ignored.

OTOH re: ARM's.

I have owed an ARM since November 1984. I opted for a 10.25% one-year rate rather than the 14% fixed rate. Am paying 3.625% now, my LTV is about 1%. There seemingly were many more years where I was "ahead" compared to when I was paying more than I thought I ought to. (Altho, my wife who knows nothing about finance keeps rebating - she finds something - me for not having refinanced at a 'low' fixed rate. My caution was always: what's low? Heck, a lot of times I was earning more in interest than I was paying on the loan.

Now, rates ARE low. That's disincentive for investors to fund home loans. That's why FNM/FRE have 90% of the business.

From Congressional Research Service; 2/1/2010; “Government Interventions in Response to Financial Turmoil† – Summary, in part:

“ . . . an unprecedented housing boom turned to a housing bust.†

“In August 2007, asset-backed securities, particularly those backed by subprime mortgages, suddenly became illiquid and fell sharply in value as an unprecedented housing boom turned to a housing bust. Financial firms eventually wrote down these losses, depleting their capital.
Uncertainty about future losses on illiquid and complex assets led to some firms having reduced access to private liquidity, with the loss in liquidity being fatal in some cases. In September 2008, the financial crisis reached panic proportions, with some large financial firms failing or having the government step in to prevent their failure."

That "unprecedented housing bubble" could not have expanded without GSE's buying and selling (providing liquidity) $2 trillion in subprime, Alt-A, Option ARM, etc. mortgages. Private investors would not hold such assets.

Why did the GES sacred cows do that?

Can you find one reason in a document entitled, "Highlights of HUD Accomplishments 1997-1999"? The document chronicles the "accomplishments under the leadership of Secretary Andrew Cuomo, who took office in January 1997."

In 1999 "Cuomo established new Affordable Housing Goals requiring FNM and FRE -- two GSE’s involved in housing finance -- to buy $2.4 trillion in mortgages in 10 years. This would mean new affordable housing for about 28.1 million low- and moderate-income families. The historic action raised the required percentage of mortgage loans for low- and moderate-income families that the companies MUST BUY from 42% of total purchases to 50% in 2001."

I blame Bush. HE DID NOT STOP IT.

"So writ that large: Hustle these foreclosures off the books of insolvent banks and onto the now improved books of private local investors who can make .40%. For local wealth on main street all over America, these auctions will be deals of a lifetime. We'll suddenly have 20M more renters - and rents in general will go down. All good things."

Right, because nothing bad could happen if property prices plunge by 60%. Like a few thousand banks closing because 2/3 of the country walked away from their mortgages.

When the angry rioters come for Arnold Kling's head because his "market seeking spontaneous order" turns out to destroy the economy I predict he will forget his pity for the 2 guys who got punched in the nose during 70's gas lines.

Why is Tyler linking to Mellonism in good faith?

Old consensus: we need Freddie and Fannie in order to make housing "affordable."

New consensus: we need them in order to "prevent further house price delclines," in other words, to make housing less affordable.

This is a slippery use of the word "affordable" in two different senses.

The "old consensus" was that F&F should act to provide for an active market in 30-year fixed rate mortgages and should lower the rate of such mortgages from what it would otherwise be. That would tend to increase and not decrease housing prices.

The "new" consensus appears to be exactly the same as the old one.


I'm not sure if you are being ironic but I'd be fine with total liquidation, but I'm not begging for it. I'm fine with slow progress. As Ricardo says, the government intervention has done the exact opposite of what most people would think was meant by "making homes affordable" even if they are partly to blame for accepting the monthly payment, negative savings, barely afloat lifestyle. But, they were tricked into thinking that 99% bank ownership is 'home ownership' and rising wealth effects was 'affordability.' It wasn't luck. I have compassion, and enough humility to hope Keynesians are wrong, but I'm not going to listen to how great they were at Fannie and Freddie's funeral.

At best, these entities served their purpose, so only statists for statisms sake can still see a need for them. I, on the other hand view things through the lens of permanence, so a bad idea now was probably a bad idea then no matter how long it looked like a good idea. The government caused this in large part, so I'll accept a slow wind-down to avoid collateral damage, but only grudgingly. It's not my job to know the details of whether it was CRA's fault or Fannie's fault, or how much it was the bank's fault versus an irrational market. The great home ownership and free credit without creditworthiness experiment was a debacle. Anything involved we can do without, even though we might choose not to cut it out immediately.

I think I'm not being clear. Here's one more try. If housing prices drop another 60% (which they won't because such a number is ridiculous fear-mongering and the actual number is probably 20-30%, which is simply going to happen anyway regardless of all the king's horses and all the king's men even if Arnold Kling were to go on sebbatical) it won't be Arnold Kling's fault. It will have been the government's fault.

And before someone says "but it was the consumer's fault!" what exactly do you think the government does? Do you think they try not to influence behavior?

So, to take the single biggest government initiative/experiment to influence (middle class) behavior ($100B+) in the history of the planet and then claim it wasn't the express purpose of the system to incentivize home ownership but is the market's fault is laughable.

(It's interesting that the liberal policy think-tank article says mortgage deduction is a failure because it didn't affect behavior enough. They also care a lot about government revenue of course. And mostly they are concerned about who are the winners and losers, but I digress. So, an ineffective goal that was ineffectively achieved by ineffective institutions has grown like a tumor around our heart. Yes, we should be very careful in exactly how we obliterate it, cut it out, and stomp it into oblivion).

Andrew at 4:14 pm on the 24th asked what was meant by "public purpose" in the paragraph quoted from the DiVenti article. Earlier in that article she summarizes four public purposes explicit in the GSE charters:
1. Provide stability in the secondary market for residential mortgages.
2. Respond appropriately to the needs of the private capital market.
3. Provide ongoing assistance to the secondary market for residential mortgages (including activities related to mortgages on housing for low- and moderate-income families involving a reasonable economic return that may be less than the return earned on other activities) by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for home mortgage finance.
4. Promote access to mortgage credit throughout the nation (including central cities, rural areas, and underserved areas) by increasing the liquidity of mortgage investments and improving the distribution of investment capital available for home mortgage finance.

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