With the Johnson-Crapo housing finance reform bill making its way through the Senate Banking Committee on a 13-9 vote, some may feel the time is finally right for housing finance reform. But a closer look at the dismal housing finance policy in the United States suggests that lawmakers have yet to learn from the mistakes of the past.
Both the savings and loan crisis of the 1980s and the financial crisis of 2008 came on the heels of periods in which housing finance tycoons had enriched themselves. The financiers partied, leaving the taxpayers with the bill.
The dysfunctional and regressive nature of policy in housing reflects the political configuration in Washington. For several decades, policies combined the efforts of social engineers clumsily seeking to expand home ownership with well-heeled interest groups skillfully lobbying for profits. The social engineers put taxpayer subsidies up for grabs, and the interest groups do the grabbing.
Johnson-Crapo continues this sorry tradition. It expands the role of Wall Street and the “shadow banking system” in housing finance, and it also sets up taxpayers as the ultimate backstop in the entire mortgage market, rather than limiting the government’s role to support where it is strictly necessary.
The bill also encourages low-income homebuyers to purchase homes before they have accumulated enough savings to afford a down payment of 10 percent or more, even though such risk-taking in the past worked out poorly both for individuals and for the nation’s financial system.
Above all, the legislation is the product of the same social engineers and lobbyists who have been so harmful in the past with their influence on public policy. If it passes, the social engineers will be happy to see the government behind the vast majority of mortgages and encouraging home “ownership” in which the purchaser has little or no equity in the home. The real estate and construction industries will be happy to see capital funneled in their direction. Above all, Wall Street firms will be pleased that the market for mortgage securities they discredited with their reckless practices will be resuscitated by government guarantees.
Genuinely effective housing finance reform would withdraw government support for the mortgage market. This can be done by gradually reducing the maximum loan size eligible for purchase or guarantee by government agencies. This was the path that public servant Edward DeMarco was headed toward at the Federal Housing Finance Agency, before he was replaced by Mel Watt—a member of the social engineering fraternity with no background in risk management or finance.
Mortgages with reasonable down payments can be originated and held by banks, with no need for government subsidies. It is also possible that mortgage securities can regain credibility if the loans backing them do not have excessive loan-to-value ratios.
If social engineers want to help households with modest incomes, they should target such households directly, rather than indirectly through subsidies that mostly enrich affluent homebuyers, Wall Street firms, and other non-needy beneficiaries. The best way to empower low-income households to purchase homes would be with savings programs that enable them to accumulate the funds necessary to make a 10 percent down payment.
If the United States is ever to enjoy sensible policy in housing, the choices will have to be made at a time when officials are focused on the public interest and firmly reject the suggestions coming from the social engineers and the special-interest lobbyists. Unfortunately, that does not seem to be the case today.
Arnold Kling is an affiliated senior scholar with the Mercatus Center at George Mason University and a member of its Financial Markets Working Group.