Overzealous intervention dooms the market

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Article Highlights

  • Government guarantees for mortgages pose needless risk to homeowners and taxpayers.

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  • Government guarantees for mortgages suffer from three flaws: the inability and unwillingness to price for risk, asset allocation distortion, and the politicization of lending.

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  • The alternative to Subprime 2.0 is a home finance market based on tried and true principles.

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Editor’s note: This piece originally appeared on June 20, 2013, in The New York Times’ Room for Debate in response to the question: Does it make sense to encourage homeownership through entities like Fannie and Freddie and through tax policies?

Those who want government guarantees for mortgages see them as a path to encourage homeownership and market stability, but instead guarantees pose needless risks to homeowners and taxpayers. Government guarantees suffer from three flaws: the inability and unwillingness to price for risk, asset allocation distortions, and the politicization of lending.

At a recent conference on housing finance reform, community and industry advocates called for a replay of the failed government “affordable housing” experiment begun in the early 1990s. That experiment cost America’s homeowners trillions as loose lending drove the homeownership rate and home prices to unsustainable levels.

Proponents of Subprime 2.0 say a government centric housing system is necessary to assure flexibility, accessibility, affordability and stability. We know from the last experiment that “flexibility” means subprime lending, “accessibility” means entitlements, “affordability” means subsidies, and “stability” means increasing leverage during boom times. For example, achieving flexibility would require the widespread use of subprime loans with low down payments, low credit-score requirements and high debt-to-income ratios.

Such a system is doomed to failure. The alternative is a home finance market based on tried and true principles:

First, the long-term credit performance of the housing mortgage market requires sound underwriting practices that result when a preponderance of loans are of prime quality.

Second, traditional prime mortgages performed well in the past because lenders required sizable down payments, solid borrower credit histories and a well-demonstrated capacity to cover household obligations.

Third, subprime mortgages lack one or more of these pillars, resulting in default rates that are many multiples of those for prime loans.

Fourth, all programs intended to help low-income families become homeowners should be on budget and should limit risks to both homeowners and taxpayers.

When policy makers recognize these four principles, the nation will have a robust housing finance sector, in which the private market and the government play appropriate and complementary roles.

Edward J. Pinto, a former executive vice president and chief credit officer of Fannie Mae, is a resident fellow at the American Enterprise Institute.

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About the Author

 

Edward J.
Pinto
  • American Enterprise Institute (AEI) resident fellow Edward J. Pinto is the codirector of AEI’s International Center on Housing Risk. He is currently researching policy options for rebuilding the US housing finance sector and specializes in the effect of government housing policies on mortgages, foreclosures, and on the availability of affordable housing for working-class families. Pinto writes AEI’s monthly Housing Risk Watch, which has replaced AEI’s FHA Watch. Along with AEI resident scholar Stephen Oliner, Pinto is the creator and developer of the AEI Pinto-Oliner Mortgage Risk, Collateral Risk, and Capital Adequacy Indexes.


    An executive vice president and chief credit officer for Fannie Mae until the late 1980s, Pinto has done groundbreaking research on the role of federal housing policy in the 2008 mortgage and financial crisis. Pinto’s work on the Government Mortgage Complex includes seminal research papers submitted to the Financial Crisis Inquiry Commission: “Government Housing Policies in the Lead-up to the Financial Crisis” and “Triggers of the Financial Crisis.” In December 2012, he completed a study of 2.4 million Federal Housing Administration (FHA)–insured loans and found that FHA policies have resulted in a high proportion of working-class families losing their homes.

    Pinto has a J.D. from Indiana University Maurer School of Law and a B.A. from the University of Illinois at Urbana-Champaign.

  • Phone: 240-423-2848
    Email: edward.pinto@aei.org
  • Assistant Info

    Name: Emily Rapp
    Phone: 202-419-5212
    Email: emily.rapp@aei.org

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