Borrowing our way to the American Dream

The New York Times noted recently that financial regulation in the mortgage market has made for some strange bedfellows: advocacy groups like the NAACP and industry groups like the American Banker’s Association have joined together to oppose more stringent regulations. While the banker groups worry about shrinking profit margins and lower salaries, advocacy groups worry that requirements forcing banks to hold mortgages on their books unless the buyer puts twenty-percent down will drive lower-income individuals out of the housing market. Since the main source of wealth (See Table 1) for the median American household is home equity, it is only natural to be suspicious of policies that make it more difficult for first-time buyers to enter the housing market. Such arrangements perpetuate the current distribution of wealth and reinforce patterns of residential racial segregation.

Unfortunately, the government’s solution is to go back to a couple of disgraced old friends. One proposal by regulators is to allow banks to off-load mortgages with less than twenty-percent down when the purchasers are government-sponsored enterprises (GSE) like Fannie Mae and Freddie Mac. Fannie, Freddie and a miscellaneous other government-guaranteed companies hold 90% of all mortgages. The catastrophic failure of Fannie and Freddie when the housing bubble burst forced the government to put the G into GSE, assuming their obligations and adding up to a trillion dollars to the national debt. Following the takeover, Republicans and Democrats agreed that the time for the government to guarantee the entire housing market had passed. Naturally, this stance ignored the hundreds of billions of dollars transferred to homeowners every year through the mortgage interest deduction, but throwing that shock into the housing market at it’s lowest ebb would probably have been a medicine that killed the patient.

Lawmakers who drafted the financial regulation are complaining that allowing GSE’s to lend with less stringent standards than private lenders misses the point. They’re right, but they miss the point as well. Crude instruments like required down-payment amounts will never force banks to stop bad lending practices; they will only shift them to some other dimension or trick. The nature of government salaries  as opposed to private ones and the low respect for public service in this country means that the banks are going to be able to hire people who can beat the regulations. Backstopping mortgage and other lending risks with government guarantees might provide cheaper homes on the front end, but ultimately, we only socialize risk while privatizing profits, which takes money away from schools, health care and other important public services. Effective regulation should focus on one thing at a time, instead of striving to hit multiple targets at once. Tying together financial reform and home ownership may seem like a good idea, but the ultimate result will benefit neither: it will only bring back the era of cheap housing and potentially reinflate the housing bubble. There are many good ways to help lower-income families build wealth, but subsidizing home ownership is no longer one of them.