Taking the Government out of Housing Finance: Principles for Reforming the Housing Finance Market

There are two theories about the financial crisis of 2007–2008. One holds that it was caused largely by a lack of effective government regulation; the other that government housing policy was primarily at fault. It is undeniable, however, that large part of the previous US housing finance system were guided and guaranteed by the government and that once again the taxpayers will bear the immense costs of government failure.

Many of the proposals for reforming the US housing finance market reflect the belief that institutional investors will buy securities backed by US mortgages (MBS) only if they are somehow guaranteed by the US government. The reality is that such government market interventions have led to large-scale taxpayer bailouts twice in the last generation.

The alternative is to ensure that only prime-quality mortgages are allowed into the securitization system. The very low delinquency and default rates on prime mortgages will be attractive investments for institutional investors and will enable the housing finance secondary market to function effectively with no government support. This will eliminate the potential for additional taxpayer losses in the future; reduce the likelihood and severity of housing price booms, busts, and bubbles; and allow the eventual elimination of the Government Sponsored Enterprise (GSE) charters of Fannie Mae and Freddie Mac.

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