The Corner

Just Say No

This oral testimony (around 25 minutes) by Arnold Kling, a former Freddie Mac economist and now my colleague at the Mercatus Center, is a must-watch. Speaking before the Senate Banking Committee on Tuesday, he urged Congress to “just say no,” to more government involvement in the housing market.

Any scheme to bring a government guarantee is comparable to building a nuclear power plant on top of a fault line

The best part is when Kling explains that “it would be naïve to think the private sector always gets things right. But even more naïve to think government could get it right. The government is captured by special interests.” As evidence, he points to the other witnesses on the panel: Mark Zandi, chief economist at Moody’s Analytics, and Michael Berman, chairman of the Mortgage Bankers Association. Both institutions would benefit from a government guarantee on mortgage-backed securitizations, which is one option under consideration. The chairman was obviously upset with Kling, but I thought it was priceless.

I have to say, the one good thing about this economic crisis is that there are so many interesting new papers to read, especially about how to reform Fannie and Freddie. For instance, here is the written testimony of e21′s Chris Papagiani before the House’s Financial Services Committee today.

And here is a good paper by economists Antony Sanders and Michael Lea asking whether or not we really need a 30-year fixed-rate mortgage. This is an important issue, since one of the central arguments for preserving Fannie and Freddie is that without them, the FRM would disappear. But would it? And if it did,, would that be so bad? Sanders and Lea explain:

To assert that the FRM is the preferred alternative for most borrowers is naïve. Many borrowers have shorter-term time horizons and can handle some interest-rate risk. Min’s assertion that the switch to shorter duration instruments would lead to massive defaults if and when interest rates increase is not supported by international experience.

We also think the prohibition of prepayment penalties on fixed-rate mortgages is misguided. Borrowers should be given a choice—long-term versus-short term fixed rates, with and without prepayment penalties. The market will price the differences giving price breaks to those borrowers willing and able to handle interest-rate risk.Following Canadian and European tradition imposition of a prepayment penalty should be limited. It should not apply to borrowers moving house and should be limited in term (e.g., 5 years in Canada, Netherlands, 10 years in Germany).

The most important result of a shift away from the FRM is a reduction in taxpayer liability for mortgage risk. There is nothing so special about housing finance that necessitates the government absorbing the credit risk of the vast majority of the mortgage market or underwriting the interest-rate risk of the that market. Two episodes with massive taxpayer loss should convince us of that fact.

The whole paper is here.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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