Wow, David Wessel of the Wall Street Journal has written a truly excellent column on “Rethinking Part of the American Dream.” I’ve been thinking about the Marron-Swagel plan for reforming the GSEs, sponsored by Economics 21. Rather impressively, Marron and Swagel note the advantages and the disadvantages of their plan in a full and frank manner. At one point in their discussion of alternatives, the discuss the mechanics of eliminating the federal role in mortgage finance.

Eliminating the federal role entirely. Under this approach, the federal government would eliminate the guarantee (either implicit or explicit) and would sell Fannie and Freddie to private investors. In the absence of the federal guarantee, it is unlikely that Fannie or Freddie would be able to offer meaningful guarantees on conforming mortgages. The two firms would likely become consulting firms, like Fair-Isaac. This reform would have wide-ranging effects on the mortgage market. The market for agency MBS would shrink (since only GNMA would continue to issue them), thus limiting one potential tool of monetary policy. Lenders would likely move more toward adjustable rate mortgages and away from 15- and 30-year fixed rate mortgages. Middle-class housing markets would be more exposed to occasional liquidity droughts, although the government could always take steps to counter severe crises. On the positive side, such a step would reduce the degree to which federal policy favors housing over other forms of investment and would maximize innovation as firms would introduce alternative financing means that have worked in other nations (e.g., covered bonds). [Emphasis added.]

In Wessel’s column, he describes the pitfalls of the 30-year fixed rate mortgage in detail.

Most other countries rely on mortgages in which the rate is fixed for only three to five years. In the U.S., one usually can refinance a mortgage without penalty to take advantage of lower rates. More than 70% of mortgage applications filed in early June were for refinancing existing loans, the Mortgage Bankers Association says. Elsewhere, refinancing is less common. Adjustable rates and prepayment penalties make it less alluring.

Wessel cites economist Patrick Lawler on the most direct result:

Mr. Lawler estimates this feature adds at least one-quarter to one-half a percentage point, probably more, to the rate on every mortgage.

But there are indirect results as well, as Wessel goes on to explain:

The cherished right to repay a mortgage and get a cheaper one creates a huge, lucrative refinancing industry whose value he questions. And it creates a need for Fannie and Freddie, which may end up costing taxpayers more than any other element of the much-reviled bailouts. Without them to guarantee repayment of a loan and lubricate the market, the 30-year fixed-rate loan would be more costly and less common. But Americans might be better off.

I still think that the Marron-Swagel approach is very attractive — as Wessel clearly understands, the political prospects of a big bang transition away from fixed rate mortgages isn’t there, at least not yet. Indeed, he ends the column with the following observation:

Today, the U.S. guarantees nearly all new mortgages, and there is no sign that’s about to change soon.

Marron-Swagel represents an attempt to make the current mortgage finance regime more transparent, more resilient, and also more accountable to taxpayers.

So why will the U.S. government continue to guarantee nearly all new mortgages? The answer can be found elsewhere in today’s Wall Street Journal, in an article titled “Industry Speeds Recovery, and Housing Slows it Down.”

“The story on housing isn’t that it’s going to collapse, it’s just that it’s not going to recover,” he said. “We’re not going to see a real recovery in the housing market until the foreclosure process gets worked out. That’s…a 2012 event.”
Mr. Harris estimated that the economy, as measured by gross domestic product, would grow 3.2% this year, but said that figure would be 1.5% higher if the housing market were behaving normally.

This, however, obscures the very good news, which is that the U.S. economy seems to be moving past its excessive dependence on the housing sector.

“What’s taking place is a change in the sources of U.S. growth,” said Joe Carson, an economist at AllianceBernstein. Demand for housing used to lead the economy into recovery, he said, but now global demand, particularly from emerging economies like India, Brazil and China, is helping bolster U.S. growth.

What’s interesting is that recently expired tax breaks designed to stimulate housing investment seem to have only delayed this process. One can argue that this was a successful example of macroeconomic fine-tuning: the economy couldn’t sustain a deeper collapse in housing starts, hence the tax breaks were well-timed and well-placed. I tend to think otherwise, but it’s not an entirely unreasonable argument.

The most important aspect of this turn away from the housing sector is its impact on the labor market. The only upside of housing overinvestment is that it helped create high wage jobs for less-skilled workers, particularly for prime-age males who’ve been leaving the workforce in disturbingly large numbers. As Matt Yglesias recently noted, the demand for skilled workers is still increasing, yet we haven’t seen a strong enough response on the supply side.