US Housing Finance: Is Government Involvement Necessary?

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.

Share of US Mortgage Debt Outstanding

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

Chief Investment Officer—Fixed Income
Douglas J. Peebles is Chief Investment Officer, a Partner of the firm, and Head of Fixed Income, focusing on AB’s fixed-income investment processes, strategy and performance across portfolios globally. As CIO, he is also Co-Chairman of the Interest Rates and Currencies Research Review team, which is responsible for setting interest-rate and currency policy for all fixed-income portfolios. In addition, Peebles serves as Lead Portfolio Manager for AB’s Unconstrained Bond Strategy, and focuses on managing the firm’s strategic client relationships. In 1997, he pioneered AB’s highly successful and innovative approach to global multi-sector high-income investing, which is now being adopted by other firms. Since joining the firm in 1987, Peebles has held several leadership positions, including director of Global Fixed Income (1997¬–2004), co-head of Fixed Income (2004–2008), and his current position (Head of Fixed Income), which he assumed in 2008. He holds a BA from Muhlenberg College and an MBA from Rutgers University. Location: New York

Michael S. Canter

Director—US Multi-Sector and Securitized Assets
Michael S. Canter joined AB in 2007 as a Senior Vice President and is currently Director of US Multi-Sector and Securitized Assets. He is also the Chief Investment Officer of AB’s Securitized Assets Fund and Recovery Asset Fund (ABRA-S), and the former CIO of the Legacy Securities (PPIP) fund. In addition, Canter is Head of the Securitized Assets Research Group, which is responsible for AB’s investments in agency mortgage-backed securities, non-agency residential mortgage-backed securities (RMBS), commercial mortgage-backed securities and other asset-backed securities. He has particularly extensive expertise in RMBS, and in 2013 was called upon to give expert testimony to the US Senate Committee on Banking, Housing, and Urban Affairs on how US housing policy should be structured going forward. In 2015, the US Department of the Treasury asked Canter to join a working group of industry leaders focused on structural changes to non-agency RMBS that could restart that market. Prior to joining AB, he was the president of ACE Principal Finance, a division of ACE Limited, from 2000 to 2006. There, he managed portfolios of credit default swaps, asset-backed securities, mortgage-backed securities and collateralized debt obligations. Canter holds a BA in math and economics from Northwestern University and a PhD in finance from the Columbia University Graduate School of Business. Location: New York

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