There is a need to reframe this GSE debate: mortgage finance policy and affordable housing policy are two different things. Whether we should subsidize low-income Americans putting a roof over their heads is one question. How we should do this is another question. But neither is necessarily relevant to how the government manipulates mortgage prices for nearly the entire housing market. Separating mortgage finance from affordable housing is an important process to shedding light on what policy options can best be pursued to prevent another catastrophic boom-and-bust.
Over the past several decades these two issues have become confused, as policymakers used GSEs to expand access to mortgage credit and advance a social mission of increasing homeownership. In 1993, as a part of the Affordable Housing Initiative, the Housing and Urban Development Department began increasing the affordable housing mandates for Fannie Mae and Freddie Mac. By 2006, the percentage of “confirming” loans the GSEs were required to purchase, based on certain standards of quality and affordability, grew from 30 percent to 55 percent.
But conflating the two policy realms has wound up failing on both fronts: the mortgage credit market is more than 90 percent dominated by Fannie Mae, Freddie Mac, and the FHA. At the same time, the homeownership rate has been falling steadily from a peak of 69.2 percent to 66.9 percent today.
Mortgage finance policy should be focused on simply establishing the rules of the game for banks that originate loans, financial institutions that securitize them, and investors who buy them. There is no inherent need for government to support this market and, as the financial crisis has painfully taught us, federal guarantees lead to credit misallocation, mispricing of risk, unstable price swings, and weakened underwriting standards, all of which contributed to the destabilization of the housing market.
Now, libertarians will not necessarily like this, but here is some good news for the debate: eliminating affordable housing goals and removing government supports for mortgage finance in the process of developing a sustainable housing market does not mean Congress has to end subsides for the poor. I will point out here that I do not think we should have subsidies for housing at all. But I will accept that with pandora's box open, it is likely impossible to eliminate all low-income housing subsidies. This aid can be pursued in more effective ways than the current system that do not distort the entire mortgage market.
For instance, it has now become universally accepted that it is not a good idea to push people into homes they cannot afford. If Congress chooses to encourage homeownership for low-income families they should ensure it is sustainable for the homebuyer. Any subsidies provided by the government should be 1) direct to the borrower, 2) on-budget and subject to appropriation, 3) narrowly targeted so as not to compete with the private sector, 4) built on sustainable underwriting standards, and 5) governed by responsible accounting standards.
Using these guidelines we can have a mortgage finance market that is funded solely by private capital and at the same time provide narrow, direct subsidies limited to low-income Americans if Congress wants to appropriate the funds as necessary. There need not be any arbitrarily established affordable housing goals.