The Case for Higher 30 Years, and Against Fannie, Freddie

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I don’t think that those who disagree with me are dumb.  It is often that the person in question is bright, but has presuppositions that disagree with mine.  I am for the most part a libertarian.  Thus I don’t often agree with liberals, or the pro-big-business wing of the Republican party.  Most of the time, I also favor regulation of financial companies, because when too many of them borrow short and lend long, something horrible happens to the economy as a whole.

The Case for Higher 30 Years, and Against Fannie, Freddie

That is the main reason why I think government encouragement of 30-year mortgages should end.  It increases leverage in the economy, and makes it more susceptible to crises.  Societies that have a lot of debt tend to be more fragile.  We forget how certain we were that Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) could never fail.  I was one of the few people that argued the opposite at  (Sadly, those posts are lost.)  Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) assumed that there would never be a sustained period where housing prices would fall across the US as a whole.  When prices began to fall, their business model was destroyed, because they were levered very high.

30-year mortgages allow some to buy houses that they should not buy.  If you have to have a 30-year mortgage instead of a 15-year mortgage, you are buying too much house for your income.  We spend too much money as a society on housing, and we take on too much debt as a result, leading to fragile financial systems.  Debt-based systems are fragile relative to equity-based systems.

If there are to be 30-year mortgages, let them be purely private, like Alt-A, Jumbo, and Subprime loans.  Don’t let the government place any guarantee on them.  If we have to guarantee mortgages, do it from 15 years and shorter.  Reduce the amount of leverage in the economy as a whole.  Make the system stronger, against those who think that encouraging borrowing is a free lunch.

What is the cost to my proposal?  Fewer people buy houses, and fewer houses get built.  Good.  We are over-housed already.  Far better that investment should go to production rather than consumption in the US (opposite in China).  We already subsidize mortgage lending through the tax code, which we should eliminate.  Why should we favor one class of borrowing over another?

Let the apartment REITs house people.  They borrow over a wide maturity spectrum, and do not rely on long-term finance.  Loss of government guarantees on 30-year mortgages will not affect them.

Now, I am responding to this article of Mike Konczal.  Here is one thing that he said:

The second [reason] is that providing macroeconomic stability is a legitimate and important function of the government. After the crash, the government had to step in, prevent a banking crisis and run the entire mortgage market after private capital disappeared. As such, the government holds the tail risk of the mortgage market imploding already; why not make this insurance explicit, while also regulating and pricing it?

Sorry, that’s not the way it works.  The Fed provided too much liquidity, and Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) provided too much lending up to 2007.  Now we suffer the bust from having over-stimulated housing demand.  The government rarely makes things more stable; they are pro-cyclical, and make things less stable.  That’s the way politicians are, because no one will oppose a boom.

We need to move to a less-levered system, where debt is discouraged, to create a system that is not fragile.  After two failures due to high debt levels (current and the 1930s), we should learn that high levels of debt lead to economic failure, and move to a system where interest in not tax-deductible, but dividends are.  This will lower debt levels, and our economy will become more stable.

By David Merkel, CFA of Aleph Blog

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