Saturday, February 12, 2011

Four quick points about Fannie-Freddie Reform

(1) Why have an explicit guarantee?  If TARP should have taught us anything, it is that there are implicit guarantees everywhere; it is better to be up-front about the fact that the government does provide backstops in times of crisis.

(2) How to price the guarantee?  Mark Zandi has a good explanation.  The hard part is going to be to keep fees up in times of low defaults.  In the early part of the last decade, Fannie and Freddie were criticized for earning excess profits on their guarantee fees, for the simple reason that defaults on prime mortgages essentially didn't exist in the 1998-2005 period.  Complaining about Fannie-Freddie's g-fees at that time would be akin to complaining the State Farm enjoys excess profits when Florida goes a year without a hurricane.

(3) In the absence of government intervention in the market, the long-term fixed-rate prepayable mortgage will likely go away.  These mortgages are expensive to households, but they also provide a level of certainty that helps households manage risk.  Households are already facing more risk than before (defined benefit pensions, anyone?), so I am not sure it is a good idea to add even more.

(4) I worry about high downpayment requirements.  It is clear that households need to put some of their own money into a house for a mortgage to be safe (gifts and grants don't count).  But while the overall homeownership rate for the US is fine, the substantial gap between whites and minorities, more than 20 percentage points, is not.  Minorities have far less wealth than whites, and across the generations, have had wealth systematically expropriated; minorities have also been discriminated against by the government in credit markets.  Massey and Denton:
In rating the home, the FHA established minimum standards for lot size, setbacks and separation from existing structures that essentially eliminated many inner-city the late 1940s, the FHA recommended the use of application of racially restrictive covenants...per capita mortgage spending was 6.3 times greater [in St. Louis County relative to the city of St. Louis].
I suppose in light of history, direct payments to the heirs of those who have had wealth systematically stripped away makes more sense than trying to close the homeownership gap.  But the latter seems more politically doable than the former.