Arnold Kling  

Housing Finance Reform

Henderson on Stossel... The Great Reconfiguration...

Peter J. Wallison, Alex J. Pollock, and Edward J. Pinto write,

Our alternative approach is to ensure that only prime quality mortgages, which comprise the vast majority of US mortgages, are allowed into the securitization system. The very low delinquency and default rates on prime mortgages will be attractive investments for institutional investors and enable the housing finance system to function effectively with no government support. This will eliminate the potential for additional taxpayer losses in the future, and allow the eventual elimination of Fannie Mae and Freddie Mac.

They offer four principles with which I agree. 1. The housing finance market can and should function without government support. 2. Any regulation should focus on ensuring mortgage credit quality. 3. All forms of housing assistance should be explicit and on budget. 4. Fannie and Freddie should be eliminated over time.

One could argue that (4) is not a principle--it just follows from (1) and (3).

The only way in which I differ is that I am not sure that as government withdraws from housing finance we will see private securitization emerge. Instead, I think we might see a reversion to the originate-and-hold model, but with a significant differential between the interest rate on 5-year adjustable loans and 30-year fixed rates loans, so that consumers begin to shift away from the latter.

In order for the buy-and-hold model to come back, a lot more capital would have to come into the banking system, whereas now a lot of that capital is in the shadow banking system. I think that can happen as a natural, evolutionary process. But things could evolve differently from what I expect.

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COMMENTS (4 to date)
Simon K writes:

The definition of a Prime mortgage is one that Fannie and Freddie would buy and securitize. So how exactly does limiting securitization to mortgages that Fannie and Freddie would buy allow you to eliminate them?

Tom Grey writes:

The law/ rules for Fannie& were changed so that they could also invest in sub-prime, Alt-A.

Along with private securitization, which might not evolve, there needs to be more concern about regulations on Tier 1 capital and AAA rated financial products.

If other rules aren't changed, and the agencies rate some "20% down payment" mortgages bundled into a securitized product as AAA, such product will be invested in by banks.

Does the above constitute "government support"? Sort of, maybe, maybe not.

The evolution of the market will be determined by what is rated AAA by the rating agencies, and what products are allowed to be counted as "money" for capital reserve requirements.

stuhlmann writes:

"Our alternative approach is to ensure that only prime quality mortgages, which comprise the vast majority of US mortgages, are allowed into the securitization system. "

I think if the rating agencies would properly examine and then honestly rate the mortgage pools, then only prime quality mortgages would be securitized. No one would invest in subprime junk if it didn't have that AAA seal of approval.

Julie Kinnear writes:

I think that a healthy mortgage market is a market regulated by itself, given that consumer have all the necessary and quality information about the market to make quality decisions that will enable them to be financially stable in the long term. Government sponsored institutions should make sure that nobody is cheating and that home buyers are informed well. Securitization is a good think as long as the securitizators are not greedy too much and don't take up trashy loans for their securities, which implies banks that don't cheat on lending standards and fail to do proper paperwork.

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