As the United States struggles to repair the damage done by the collapse of the subprime lending market and subsequent financial meltdown, the Congressional Budget Office has offered its overview of possible future courses. Jacob Goldstein, of NPR's Planet Money, brings the overview: This year, the federal government guaranteed the vast majority of mortgages issued in this country. And about half of all of the outstanding mortgages in America — not just those issued this year — are now backed by the government .... .... Yesterday, the CBO released a report that gives a useful overview of the possibilities — from a government-run agency that guarantees a wide range of mortgages, to some sort of hybrid, to a fully private system. Here are a few of the pros and cons for each option, as described by the CBO: 1. Government-run Under this system, a government agency would be created to guarantee a wide range of mortgages. It would be paid for wholly or partly by fees paid by borrowers. Pros: Steady flow of funds to the mortgage market, even during times of "financial stress." "Most of the federal subsidies would probably flow to mortgage borrowers rather than to private financial institutions." Cons: "Greater federal presence could tilt the allocation of capital in the economy further toward housing and away from other activities." "Taxpayers, rather than private financial institutions, would bear much of the credit risk on guaranteed mortgages." 2. Hybrid In this system, private companies would charge fees and guarantee mortgages, and make profits or take losses depending on how the mortgages perform. The federal government would charge fees and issue limited guarantees, which would kick in under extreme circumstances if the private companies were wiped out. Pros: "Limit costs and risks to taxpayers" by having private companies take initial losses During times of financial stress, limited government guarantees could help keep funds flowing to the market Cons: "Experience with other federal insurance and credit programs suggests that the government would have trouble setting risk-sensitive prices and would most likely end up imposing some cost and risk on taxpayers" Might result in some of the same problems that arose with Fannie and Freddie: A market dominated by a few players who are likely to capture their regulators. 3. Private Under this system, the government's active role in the mortgage market would be limited to affordable housing programs, such as the FHA. Everything else would be left to the private market. Pros: Would likely increase competition, which would "reduce the market’s reliance on the viability of any one firm." May be the best way to "allocate the credit risk and interest rate risk" associated with mortgages Cons: Everyone might assume that the private companies would be bailed out by the government in a crisis, "weakening market discipline, reducing transparency, and creating moral hazard." Taxpayers might still wind up on the hook for losses in a crisis, particularly if the risks wound up being borne by banks that are covered by the FDIC. Naturally, this is the simplified outlook. The actual report is strung together of long sentences spattered with acronyms, and describes only generalities—thus leaving the issue open to all manner of political distortion and argument. In the end, one might wonder, "Public, private, and something in between? Well, that isn't exactly helpful." After all, few initiatives look in practice like their general conceptualization on paper. Beyond the broader consideration of public/private/hybrid, the Devil really will be in the details. It is possible to take the riskiest system (e.g., private) and make it work; it is also within our grasp to take the safest (public) and completely blow it all to hell. Or, how different would the future hybrid look compared to the mix of public guarantees and private sector loans we have today? Still, though, the spectre persists. Living through these economic times brings the troubles of past instability viscerally closer. Many look at a financial system that breaks at least twice a century and wonder what routes might avoid the seemingly inevitable breakdown. And as some have noted in recent months, if it's not housing, it will be something else—earlier this year, for instance, we heard murmurs about scheming life insurance much as the market did mortgages. So perhaps two questions emerge: Should we do anything to secure the market? and What should we do to secure the market? ____________________ Notes: Goldstein, Jacob. "Should The Government Be In The Mortgage Business?" Planet Money. December 23, 2010. NPR.org. December 23, 2010. http://www.npr.org/blogs/money/2010...ld-the-government-be-in-the-mortgage-business Congressional Budget Office. Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market. December, 2010. CBO.gov. December 23, 2010. http://www.cbo.gov/doc.cfm?index=12032
