Housing Finance: Two strikes, and now?

Published in the Urban Institute.

Memories fade. So while trying to draw conclusions about going forward, we should also do our best to remember our past expensive lessons in politicized housing finance.

It should be most sobering to Americans engaged in mortgage lending that the U.S. housing-finance sector collapsed twice in three decades—a pretty dismal record. There was first the collapse of the savings and loan-based system in the 1980s, then again that of the Fannie Mae and Freddie Mac-based system in the 2000s. The first also caused the failure of the government’s Federal Savings and Loan Insurance Corp.; the second forced the government to admit that the U.S. Treasury really was on the hook for the massive debt of Fannie and Freddie, frequent protestations to the contrary notwithstanding. The first generated a taxpayer bailout of $150 billion; the second, a taxpayer bailout of $187 billion. That’s two strikes. Are we naturally incompetent at housing finance?

In both cases, the principal housing-finance actors had tight political ties to the government, which allowed them to run up risk while claiming a sacred housing mission. The old U.S. League for Savings, the trade association for savings and loans, was in its day a serious political force and closely linked with the Federal Home Loan Bank Board. In their glory days, in turn, Fannie and Freddie bestrode the Washington and housing worlds like a hyper-leveraged colossus. In retrospect, these were warning signs.

The savings and loans did what the regulators told them to do: make long-term, fixed-rate mortgage loans financed short. Fannie and Freddie were viewed as a solution to this interest-rate-risk problem, then had a credit-risk disaster instead. They, too, did what the regulators told them to do: acquire a lot of lower-credit-quality loans. Thinking that regulators know what risks will come home to roost in the future is another warning sign.

We need to eschew all politicized schemes and move to something more like a real housing-finance market, if we want to avoid strike three.

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