Housing Finance Should Take Cues From Other Countries - FSC
The House Financial Services Committee (FSC) held a hearing today titled: "Beyond the GSEs: Examples of Successful Housing Finance Models without Explicit Government Guarantees." According to Jeb Hensarling (R-TX), committee chairman, "The hearing will examine the mortgage finance systems of other countries to determine whether a sustainable system of housing finance is possible that does not rely on government-sponsored enterprises or government subsidies."
Five witnesses were scheduled to appear before the committee. We have extracted a portion of the testimony of three.
Dr. Dwight M. Jaffee, Booth Professor of Banking, Finance, and Real Estate Haas School of Business University of California, Berkeley said that current discussion regarding GSE reform focuses on two alternatives. The first would allow the private markets to replace GSE functions and the second would create a government successor to continue guarantees against borrower defaults. His research, he said, leads him to a strong endorsement of the former for two reasons..
"First, there is strong evidence that the private markets would operate at a standard substantially higher than that actually experienced under the GSE regime." He cited as evidence that mortgages originations have always been a 100 percent private market activity; banks and other private investors have always owned the vast majority of mortgages, and most of the innovations in the market - asset backed securities, commercial mortgage backed securities, and jumbo mortgages came from the private sector and mortgage backed securities (MBS) were not invented by the GSEs but by Ginnie Mae.
Second, experience indicates that a new government mortgage guarantee program would again leave taxpayers at high risk, while creating little or no sustainable increase in American home ownership." Jaffee said, however, that there is a valid role for the FHA and VA to operate in their traditional manner with precisely defined programs to provide benefits to lower income households and service veterans.
The European Union rules prohibit member states from creating entities such as the GSEs, since the subsidies are considered an unfair trade advantage. A comparison of these EU countries with the U.S. thus provides another test of the GSE impact. The results show the European countries outperforming the U.S. on virtually every measure of housing and mortgage market performance. Perhaps the most stunning claim, is that the U.S. home ownership rate equals only the average of 15 major Western European countries and that the market has been substantially more stable than that of the U.S.
Dr. Michael J. Lea Director The Corky McMillin Center for Real Estate at San Diego State University also compared the current U.S. housing finance system to that of other countries, focusing on Canada, Denmark, Germany, and the United Kingdom.
The U.S. is unusual in the extent of government involvement Lea said. Of the 13 countries he has surveyed only Canada and Japan have government guarantee programs and only Canada and the Netherlands have government-owned mortgage insurance companies. In those countries that do have government mortgage support the market share of that support is far less than the 90 percent in the U.S. and that support comes through the banking systems, such as through deposit insurance or catastrophic support.
Second, no other developed country has a GSE. They were created primarily for political rather than policy reasons and rose to dominance as a result of economic and consumer protection policy. "It is fair to say that policy makers never intended to create a duopoly providing over 75 percent of all mortgage credit in the US," Lea said.
Third, only one other country, Denmark, uses a fixed-rate mortgage (FRM) as a major instrument and it has a safer and more efficient way to fund it. The FRM has large costs to the consumer, lender, and government and its continued dominance should not be a public policy objective. Average mortgage rates may be lower if borrowers switch to shorter term fixed-rate and adjustable rate mortgages.
Lawrence J. White, Professor of Economics, Stern School of Business, New York University said that housing is no exception to the rule that when prices are reduced, in this case through government subsidies, people will buy more of it. Tax incentives for home ownership and subsidies embedded within the GSE programs have led households to buy more house, that is larger and better appointed homes on bigger lots. This has meant in turn that more of the economy's resources have been devoted to housing and less to other investments that would have been more productive. These would include business investments in plants and equipment, government investments in schools and roads, and individuals' investments in better education and training.
White specifically referenced a study, although 25 years old, that estimated that the U.S. housing stock was 30 percent larger and the GDP 10 percent smaller than it would have been in the absence of widespread subsidies. More recent studies (not specified), he said, have substantiated these findings and, further, most of these subsidies have tended to benefit upper-income households.
These subsidy programs have tended, at best, to have only marginal effects on home ownership rates and rental subsidy program would tend to have the opposite effects. Again, the subsidy programs tended to affect upper income households who would buy anyway and thus used the subsidies to leverage more house.
White said for overall housing policy the most important policy measures would be cutbacks in the overall levels of subsidies and replacing the mortgage interest deduction with a tax credit would be a good place to start. He also favors phasing out the GSEs and replacing them with a housing system that is largely privately supported.
Also testifying during the hearing were Alex J. Pollock, Resident Fellow, American Enterprise Institute and David Min, Assistant Professor of Law, University of California at Irvine