A Privatized U.S. Mortgage Market

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1 A Privatized U.S. Mortgage Market Dwight Jaffee Haas School of Business University of California, Berkeley Presented to Conference on The GSEs, Housing, and The Economy Reagan Center, Washington DC, January 24, 2011 Dwight Jaffee, 2011 Page 1

2 Agenda I briefly comment on the cost/benefit of reestablishing the GSEs, and conclude they should/will be abolished. The issue is then to recreate the U.S. mortgage market. My proposal is to establish a primarily private market for U.S. mortgage originations and investments. This includes transition steps to get from here to there. I will also comment on the primary alternative, namely to have the U.S. government guarantee all conforming mortgages, including hybrid variations on this proposal. Dwight Jaffee, 2011 Page 2

3 Abolishing the Housing GSEs It is clear that the GSE private/public hybrid has created immense losses for U.S. taxpayers. But were there benefits? Looking at 3 main mission goals, my conclusion is that GSE benefits are small. mortgages for low- and moderate-income families (and) central cities, rural areas, stability in secondary market for residential mortgages (i.e. on-balance-sheet portfolios) promote access to mortgage credit throughout Nation (i.e. mortgage-backed-securitization). Dwight Jaffee, 2011 Page 3

4 A Private Mortgage Market Proposal Basic principle: In absence of a market failure, private markets generally dominate government. FHA/HUD programs should continue to support lowincome, first-time, homebuyers and multifamily. Transition plan: Reduce conforming loan limit by $100,000 annually until it reaches zero. Allow retained balance sheet portfolios to run off. Safety net: FHA and GNMA could be rapidly expanded for conforming mortgages if needed. Dwight Jaffee, 2011 Page 4

5 Privatized Mortgage Market: Q&A Q: The GSEs and FHA now run 95% of the US mortgage market. How can we run the market without substantial government support? A: This is crowding out 101. Subsidized government credit programs always crowd out private activity. European evidence is that private mortgage markets outperform government dominated markets. Q: Who will fund all the mortgages if it is not GSEs? A: The same investors who purchase GSE debt/mbs will hold high quality private mortgage securities. Dwight Jaffee, 2011 Page 5

6 Share of Total Home Mortgages Outstanding, by Holder Depository Institutions Fannie Mae and Freddie Mac Market Investors 80% 70% 60% 50% 40% 30% 20% 10% 0% Dwight Jaffee, 2011 Page 6

7 Privatized Mortgage Market: More Q&A Q: Will mortgage rates rise? House prices fall? A: Mortgage rates may temporarily rise and house prices may face some temporary downward pressure. Ultimately, safer mortgages will lead to lower rates. Q: What about American Dream of homeownership? A: We produced 12 million single-family homes during 2000s. The problem is to make these affordable. Western European countries have achieved comparable homeownership rates with virtually no government role. Dwight Jaffee, 2011 Page 7

8 Private Mortgage Market Performance: Evidence from Western Europe Very limited government support or intervention of any form (except for programs comparable to FHA). Borrowers, lenders, government are unified to create very safe mortgage loans so default is a rare event. Europe shows major diversity in contract features (FRMs, ARMs, prepayment, recourse, maturity, etc.) There is no evidence of low homeownership rates. Mortgage rates are lower, markets are more stable. Dwight Jaffee, 2011 Page 8

9 Comparative Performance of U.S. and 15 Western European Countries Home ownership rates: U.S. is 8 th of 16. Housing Start Volatility: U.S. is 5 th of 16. House Price Volatility: U.S. is 4 th of 16. Mortgage rate spread: U.S. is 1 st of 16. Mortgages outstanding/gdp: U.S. is 5 th of 16. Dwight Jaffee, 2011 Page 9

10 European Mortgage Troubles Dwight Jaffee, 2011 Page 10 Table 4: Troubled Mortgages, Western Europe and the United States 3 Month Arrears % Impaired or Doubtful % Foreclosures Year Belgium 0.46% 2009 Denmark 0.53% 2009 France 0.93% 2008 Ireland 3.32% 2009 Italy 3.00% 2008 Portugal 1.17% 2009 Spain 3.04% 0.24% 2009 Sweden 1.00% 2009 UK 2.44% 0.19% 2009 U.S. All Loans 9.47% 4.58% 2009 U.S. Prime 6.73% 3.31% 2009 U.S. Subprime 25.26% 15.58% 2009 Source: European Mortgage Federation (2010) and Mortgage Bankers Association for U.S. Data.

11 A Private Market will Provide Expanded Mortgage Choice Adjustable or fixed rate mortgages Prepayment penalties or not; Recourse or not; Alternative amortization patterns, maturity. 30-year fixed rate mortgages will be more available: GSE MBS force all interest rate risk on investors; GSEs standardized no prepayment penalties; Long-term mortgages promoted through covered bonds; Denmark among other examples. Private markets dominate TBA forward markets Dwight Jaffee, 2011 Page 11

12 Dwight Jaffee, 2011 Page 12 A Private Market will Create Safer Mortgages Private market will contain 3 mortgage investors: Private label MBS investors; Covered bonds (bank securitization) investors; Bank portfolio investors. In the absence of government interventions, these investors must face the default risk directly: European markets show that, without government backstops, investors opt for safe mortgages. Key will be lower LTV ratios and recourse. Bank regulators must enforce the high standards.

13 Alternative Proposal to Replace the GSEs A key alternative proposal is to create government guarantees for all conforming-size mortgages. I grant this is better than insuring the GSEs; But European data indicate no market failure. Inevitably, the government will subsidize risky loans. Uniform result of government insurance programs: Unable to deny program access to high-risks; Failure to impose risk-based pricing; Government endorses risk-taking, then must bail out. Dwight Jaffee, 2011 Page 13

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