Conservative politicians and commentators have been saying for the past two years that a major weakness of the Frank-Dodd financial reform bill was its failure to address the problems caused by the government’s involvement with mortgage giants Fannie Mae and Freddie Mac. The conservatives were right.
The Obama Administration believed that including the issue would have made an already large bill too large, and said they needed more time to come up with a plan. Now the Administration has released its recommendations, and we can appreciate the bind the government finds itself in.
Public anger at the bailouts was largely directed at banks, but those bailouts have largely been repaid and often turned a profit. Meanwhile, the cost of bailing out Fannie Mae and Freddie Mac is approaching $200 billion and will continue to grow. Between them, Fannie and Freddie guarantee 85% of all the mortgages in America; with a backlog of foreclosures and declining home prices, Uncle Sam will be on the hook for billions more.
The obvious solution is to get the government out of the market. The problem is that if Fannie and Freddie are sold off, and the government ends its commitment as the insurer of last resort, the housing market could crash again and lead to another recession. Hence the Administration’s bind: on one hand an unsustainable policy that needs to end, on the other the prospect of even greater economic pain.
The Administration’s plan would come close to eliminating government support of the housing market. But—even in the plans where Fannie and Freddie are eventually privatized—the government would still back certain mortgages, and support would be withdrawn gradually over many years. This makes sense, since the last thing we need now is another recession. It would still be best if the government got out of the housing market entirely within 10 years.
Congress will decide which if any of the Administration’s recommendations become law, and it is unclear how far lawmakers are willing to go to end a half-century of government-guaranteed home mortgages. If they really want to get serious, they could also address one of the “third rails” of American politics, the home mortgage interest deduction: it costs the Treasury billions a year, it’s regressive, and it increases suburban sprawl.
Whatever happens, the era of massive direct government promotion of home ownership is likely to end. This will probably lead to higher mortgage interest rates and, in turn, lower home prices. It’s something to keep in mind for people who look at residential real estate as an investment; the long-term trend for home prices is not favorable and could get worse.