Is reform worth inevitable rate hikes?

by Ryan Smith21 Apr 2014
One of the main roadblocks to reforming the mortgage system has been the fear that moving more risk to the private sector would increase costs for borrowers. But now a former assistant secretary of the Treasury is calling that fear “misguided.”

Legislation put forward by Sens. Tim Johnson (D-S.D.) and Mike Crapo (R-Idaho) would wind down Fannie Mae and Freddie Mac, replacing them with a new federal mortgage system that would put more risk on the shoulders of private investors. The bill would require investors to put up their own capital in an amount equal to 10% of the mortgages receiving a government guarantee.

Many industry groups and housing advocates have lobbied for the government to retain Fannie and Freddie, saying that winding them down would inevitably increase consumer costs. But Phillip Swagel, a professor at the University of Maryland’s School of Public Policy and a former assistant Treasury secretary, says the additional cost would be small and called the concerns “a misguided obsession.”

“The 10 percent capital requirement is large enough to protect taxpayers,” Swagel wrote in an op-ed for the New York Times. “Fannie Mae and Freddie Mac together in the crisis suffered losses of about 4 percent of the value of their assets, meaning it would take an economic upheaval considerably worse than that of the last seven years to burn through the private capital protecting taxpayers. In exchange for the increased role of the private sector, the existence of the secondary government backstop would ensure that mortgages remained available to Americans across financial market ups and downs.”

Swagel admitted that adopting the Johnson-Crapo system would almost certainly mean a hike in mortgage interest rates. But the protection it would provide to taxpayers would be worth the increased costs, he wrote.

“Before the financial crisis, advocates for reforms were sometimes attacked as ‘antihousing,’ on the grounds that the higher interest rates from reduced government support would make it more difficult for Americans to become homeowners,” he wrote. “This complaint is misguided, since the impact on interest rates from the Crapo-Johnson is the consequence of fixing the flaw in the old system that left taxpayers at risk: the higher cost for borrowers corresponds to the protection for taxpayers that was missing.”

What do you think? Is mortgage reform worth the attendant hike in interest rates? Would the Johnson-Crapo system do more harm than good? Tell us your thoughts in the comments below.


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