Tuesday, February 08, 2011

How GSE's Stifle Mortgage Finance Innovation

Peter Wallison wrote a clearly expressed editorial in a recent edition of the Wall Street Journal explicitly identifying the GSE-provided subsidy to conventional 30-year, fixed-rate mortgages.

Wallison's point was that many people mistakenly believe that you can't offer an uninsured 30-year, fixed-rate mortgage, completely ignoring the existence of the jumbo-loan market. He went on to catalogue the mistakes Fannie Mae made in easing eligibility requirements for its mortgage guarantees, including downpayments of as little as 3%.

The editorial got me thinking about the reasons for such long duration mortgages. Wallison pointed out that they build equity value very slowly, maximizing the interest expense deductions available in the current tax code.

If I'm not mistaken, part of the reason for the lengthy duration was the experience Americans had with balloon-payment mortgages of shorter duration during the 1930s. When monetary policy brought about a severe contraction of the monetary base, money simply wasn't to be had. And many borrowers probably couldn't requalify for a mortgage during the Depression.

I'm familiar with the current existence of shorter-duration mortgages, but, of course, those leave a homeowner vulnerable to needing to refinance at an inopportune time. Those mortgages don't typically get the exposure that traditional 30 year fixed-rates do. However, many homeowners never come close to living in their home for 30 years.

Is it possible that the GSE's backing of selected mortgages stifled innovation in the field? Wallison concentrates on the dubious policy of government subsidies to conventional mortgages. But it occurs to me that another cost of those subsidies is to make it harder for other, more innovative mortgages to gain popularity. I'm not talking about lower downpayments but, rather, a homeowner choosing to take duration risk in exchange for a lower rate.

It would seem that, as is frequently the case, government-sponsored distortions in credit markets may have created unintended consequences which rob consumers of more choices in their buying behaviors. In this case, in choosing the duration of their mortgage, should they have reason to believe they do not need a 30-year funding commitment.

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