A debate is raging about whether the US government’s significant role in housing finance is sustainable. In future articles, I will explain in detail why we believe the private sector needs to play a greater role in the future of housing finance. But for now, let’s take a step back and ask a key question. Is government involvement in the US housing market necessary at all?
The US government’s involvement in the housing market is deeply rooted in history, stretching right back to before World War II. Through various tax incentives and the backing of government-sponsored entities (GSEs) such as Fannie Mae and Freddie Mac, the government has achieved key policy goals, such as reducing mortgage rates and promoting home ownership. The massive losses suffered by Fannie Mae and Freddie Mac, which taxpayers have had to absorb, were unintended consequences of these policies.
Since the US housing bubble burst, home prices have declined nationwide for the first time since the Great Depression; Fannie and Freddie have been placed into conservatorship; and the supply of private capital to the housing market has dried up. That’s left an even bigger government footprint on the market than before, as the display below shows.
What Is to Be Done?
As my colleagues Michael Canter and Matthew Bass argue in a recently released white paper, Increasing the Role of Private Capital in the Mortgage Market, the private sector needs to take the lead in housing finance, acting as the first line of defense against any losses.
We believe the government’s role should be limited primarily to ensuring market stability, promoting standardization of loan underwriting, documentation and other processes, and providing a catastrophe guarantee—essentially, helping to maintain market liquidity in times of severe market stress. Those government responsibilities are still necessary to ensure a stable and well-functioning market.
With $5.4 trillion in outstanding securities, agency mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae make up one of the largest and most liquid fixed-income markets in the world. The growth of this market was supported by a large, diverse base of global investors attracted by its deep liquidity, apparent lack of credit risk and attractive yields relative to US Treasuries.
Without a government guarantee, many of these buyers would likely disappear. How would mortgages be financed? Probably in the same way as before the advent of securitization: banks would make mortgage loans and hold them. As a result, credit availability would likely become more constrained: many fewer people would be able to obtain a mortgage, and those who did would pay higher interest rates.
Furthermore, concentrating more mortgage risk on the balance sheets of banks that are already large would increase systemic risk in the banking system. It would also increase the banking system’s reliance on more volatile wholesale funding, posing another potential threat to financial stability. As we saw in the recent credit crunch, wholesale funding (unlike bank deposits) tends to disappear in market crises.
Thus, we don’t think a fully private housing-finance market is a realistic option. Still, it’s important that taxpayers don’t have to absorb the risk of a government guarantee. That’s why a new model for housing finance is needed. I’ll explore this subject more in future posts.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio- management teams.
Douglas J. Peebles is Chief Investment Officer and Head of Fixed Income, Michael S. Canter is Director of Structured Asset Research and Portfolio Management, and Matthew D. Bass is VP— Structured Assets, all at AllianceBernstein.