Government Mortgage Guarantees Lead to Bailouts
Government mortgage guarantees create moral hazard
August 13, 2013
The answer to this fundamental question is no. Given the spectacular failures of U.S. housing finance and the enormous cost to taxpayers of two massive bailouts in twenty years, the housing industry should be required to show why it needs government support again.
No other developed country provides anything that approaches the support for housing provided by the U.S. government, and many of these produce higher homeownership rates, lower mortgage-interest rates and fewer losses when defaults occur. The Housing Finance Reform and Taxpayer Protection Act of 2013 (known as the Corker-Warner bill), would expose the taxpayer to yet a third bailout.
The taxpayer losses are the inevitable result of extending government guarantees or subsidies to the housing finance industry. The U.S.-backed finance system fails because of its connection to the government.
Government guarantees create moral hazard on two levels. First, by assuring the housing industry of a steady supply of underpriced funds, government support encourages overbuilding and speculation. In addition, by relieving investors of risk through a guarantee, government support makes it possible for mortgage originators to offer liberal lending terms such as zero or low down payment loans and loans to overextended and credit-impaired borrowers.
As the Obama administration noted in the report it issued in 2011, a private mortgage finance system reduces risk. "Risk throughout the system may also be reduced," simply because of the fact that it is private: "Private actors will not be as inclined to take on excessive risk without the assurance of a government guarantee behind them."
Supporters of Corker-Warner point to the requirement for a 10 percent private, first-loss provision as protection against taxpayer loss. On the contrary, such a provision invites weakening over time and leads to political manipulation of the markets which will inevitably result in ever more risky mortgages. This is exactly what Congress did in 1992, which led to the housing bust of 2007.
There is an alternative. The Protecting American Taxpayers and Homeowners Act of 2013 (the PATH Act recently approved by the House Financial Services Committee) would better protect the taxpayers and create a more stable mortgage market for all.
Before Congress considers any action on the future of housing finance, it should ask why does virtually the entire Government Mortgage Complex support Corker-Warner? This is the same lobby that supported Fannie and Freddie for many years. Why put the taxpayers at risk again?
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