Several of you have asked what I meant when Joe Nocera yesterday quoted me calling mortgages a “social entitlement.” Did this mean I want Fannie and Freddie privatized into oblivion, taking out FHA for good measure? No, indeed – to call something a social entitlement isn’t, at least for me, to damn it. Rather, it’s to argue, as I’ll do here in more depth, that we need to weigh the cost of federal direct and indirect support for residential mortgages against all the other urgent calls on national resources. Housing for housing’s sake – the proverbial “American dream” – is an ill-considered and, as we learned the very hard way, a costly call. Instead, we need far better to target federal support, making it direct and transparent, to clearly-identified groups of borrowers. Right now, anybody who wants a high-LTV mortgage for a $750,000 condo can get a loan backed by a full-faith-and-credit USG seal, while many other vital national needs – biomedical research, infrastructure, poor kids and so much else – go ill-met at best. Surely, we can do better to balance housing policy with all our other national priorities.

With the introduction this week of the Corker-Warner GSE rewrite, this question has taken on new urgency. This bill is premised on the need for a continued USG guarantee that, while considerably scaled down from current levels, would still put the U.S. eagle atop trillions of middle-class mortgages. The rationale for this is simple: it’s impossible to securitize $4.5 trillion or so in residential loans without a TBA (to be announced) market that ensures overnight liquidity, central-bank demand, securities-financing collateral eligibility, MMF appetite and a host of other benefits that make MBS immediately liquid. The key to TBA is the USG guarantee (for Ginnies) and agency stamp (for Fannie and Freddie) that make investors indifferent to the credit risk that would otherwise vary wildly based on the nature of individual mortgages backing each MBS. With TBA, investors need worry only about prepayment risk and several others resulting from potential changes in applicable interest rates.
Without a USG or agency backstop, investors will need to look through to individual mortgages and, thus, come in and out of the MBS market at differing prices at different times in ways that undo overnight liquidity and all the other characteristics that support trillions in U.S. MBS. To be sure, investors did create a remarkably liquid secondary market for subprime private-label paper during the boom years. This, though, resulted not from investors’ ability to parse mortgage risk, but rather to credulous faith in credit ratings. If we want a TBA market based on AAAs, I suppose we could have one, but I personally will then head for the hills.
So, we need TBA for a liquid market and to get TBA we need a USG stamp. From this, I suggest we think carefully through which borrowers should get the benefits of this costly coverage. My own recommendation: first, limit eligible mortgages only to owner-occupied properties. The Corker-Warner bill, like current policy, would continue to allow the federal backstop for vacation and investor properties. This makes them cheaper to finance, but I think it’s fairly straightforward to argue that scarce federal resources should not support ski-in, ski-out.
Second, we should income target loans eligible for the new federal guarantee. The current $729,750 limit granted FHA no longer applies to Fannie and Freddie, but the $625,000 ceiling now in effect and the $417,000 one reinstated by Corker-Warner are still way higher than the national median house price of $208,000. And, many states have housing prices well below this median, meaning that current ceilings permit not just USG support for luxury investor properties, but also very high-end housing in many parts of the country.
In my view, what makes mortgages a social entitlement is that pretty much anyone now can get one for any property, even if the borrower could easily afford the house without a USG guarantee. Sure, the loan without a federal backstop might cost more, but many of them would land not in the secondary market, but rather back on bank balance sheets. This would be good not just for banks – especially smaller ones – but also for borrowers who would be far less likely to be lost in a maze of robo-voices at call centers when trying to resolve a problem or arrange a loan modification.
Come to think of it, the current system doesn’t just provide a social entitlement to middle- and upper-class borrowers. It also provides a not-so-social one to Wall Street that can engage in credit transformation without the bother of regulatory capital or all the other costly rules to which banks are heir. Time for a change.