Wednesday, December 01, 2010

Fannie, Freddie, the FHA

The big question is whether we need them. Fannie and Freddie have cost the taxpayer an absurd amount. Yes, I know, they were innocent victims of all other banks malfeasance (that's why they required the biggest bailout? "hmm" he says with a furrowed brow). What is the reason for Fannie, Freddie, and the FHA? Ostensibly they make home ownership more affordable by providing lower mortgage rates. However, if you have a lower mortgage rate then by extension you can afford a larger mortgage thus pushing up home prices in the aggregate and wiping out any savings.

So what is the point of the big three Government Mortgage Giants (I am throwing FHA in here because they are originating most of the loans in the market and my guess is they will be costing the taxpayer an obscene amount shortly). Affordability they don't provide. I think the answer is to provide liquidity in the mortgage market and facilitate a cheap 30 year fixed rate mortgage. I have a 30 year fixed rate mortgage and certainly would prefer one all things being equal. However, all things are not equal. In order to provide me with a 30 year fixed rate mortgage the taxpayer and banks ends up taking the interest rate risk as opposed to the homeowner. If in fact a 30 year fixed rate mortgage is so desirable it stands to reason that banks would offer a 30 year mortgage without a guarentee from the feds. Such a mortgage, one without a guarentee would probably be priced significantly higher then current mortgages, but again, if people are so averse to interest rate risk then they should be willing to pay a higher rate. Alternatively, more people would be inclined to do 5 year ARMS like they do in Canada and continually roll over the debt until the principal is paid down. This would expose the homeowner to interest rate risk that they currently do not face but would also likely encourage homeowners to paydown their principal more rapidly. Some homeowners would find that they couldn't roll over their debt and would lose their homes. The flipside though is that "some homeowners" are less likely to extract massive bailouts from the government than Goldman Sachs and Citigroup when they are unable to roll over their debt. My two cents.

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