Mortgage finance needs new foundation
Fixing up U.S. mortgage finance involves more than just Fannie Mae, Freddie Mac and the private home loan market. The Obama administration was right to finally put the bailed-out mortgage giants on center stage at a conference convened on Tuesday. But the crisis had a third leg: borrowers got ahead of themselves.
In the decade of easy money before the crash, homeownership rates shot up to 69 percent by 2004 from an historical and fairly steady average since the 1960s of roughly 64 percent. This effectively means 5 million properties were bought by people who perhaps should never have owned them. The rate had dropped back to about 67 percent as of June, implying part of the excess has been painfully worked out.
Some of the ways to limit future bubbles aren’t new. First, borrowers should have to make a healthy down payment. By 2006, some 70 percent of subprime borrowers had mortgages worth at least as much as their real estate. Second, lenders should concentrate on the borrower’s ability to repay the loan rather than on the potential increase in value of the property. The crash has already imposed some of this discipline. But credit standards will loosen again — and regulators must be ready to rein in recklessness.
A third idea is less obvious: Give lenders recourse to the borrower when a home loan goes sour, not just to the property. That’s how Canada does it. It’s no panacea, but being on the hook ought to discourage home buyers from borrowing more than they can really afford.
A fourth idea would be to curtail the ability to refinance. The U.S. market is almost unique in offering 30-year, fixed-rate mortgages that can be refinanced at lower rates at very little cost thanks to Fannie and Freddie’s participation. But the uncertainty and built-in expense discourage private-sector mortgage lending.
The last in a handful of possibilities would be to reduce or eliminate the tax deductibility of interest. Of course, all these measures would make mortgages harder to get, more expensive, or both. But considering the recent damage caused by blind belief in the dream of home ownership, it might be no bad thing.