Don't take the government out of mortgages, argues economist

by Adam Smith14 Nov 2013

A White House economist has stressed the need for a continued government mortgage guarantee, regardless of the fate of Fannie and Freddie.

In a speech to the Urban Institute, White House economic adviser James Stock said there was a role for both the private sector and the government in backing mortgages. He said cyclical housing downturns meant that the government needed to maintain some involvement in the mortgage sector.

"The virtues of private sector competition apply to housing finance, including service delivery, innovation, price discovery, private sector means for diversifying risk, and developing financial products that draw on worldwide sources of funding for U.S. mortgages. A reformed housing finance system should therefore put the risk and rewards of mortgage lending in the hands of private actors. But financial markets are not perfect, and the government has a role in reducing the impact of financial market failures on real economic activity, especially when those failures are exacerbated in a cyclical downturn," Stock said.

Stock argued that the private sector needed the aid of a "countercyclical" government role to provide support in the event of market failures, a role he said only government could play.

"It is hard to see how a private guarantor could credibly provide full insurance because of its inability to diversify against severe common, or macro, risk. The presence of a government guarantee, as opposed to a private guarantee, resolves the credit risk asymmetric information problem associated with MBSs that do not yet have their constituent mortgages fully specified."

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