Current mortgage rates won't survive the demise of Fannie and Freddie
March 10, 2011
What to do about Fannie and Freddie?
That is perhaps the most weighty finance question facing Washington these days. Fannie Mae and Freddie Mac have long provided the liquidity needed to keep mortgages easily accessible in the United States. This was fine during good times, but the flaws in the system became painfully obvious in the housing crisis of the past few years. The upshot is that mortgages may be tougher to get in future years--and current mortgage rates may have to rise.
The fundamental flaw
Fannie Mae and Freddie Mac have been government-sponsored entities, meaning that while they've operated as private companies, the government has guaranteed their investments. The logic behind this was that this government security gave everyone in the chain of mortgage financing the confidence to make available the capital necessary to fund mortgages. This has allowed Americans easy access to mortgages.
The flaw is that if you give executives a profit motive to take risk, but provide them with a government safety net should risk turn against them, then they are going to behave irresponsibly. Fannie Mae and Freddie Mac executives benefited from high profits during the housing boom, but did so in part by relaxing underwriting standards. The result was that they financed a huge volume of bad mortgages--according to the New York Times, losses from these mortgages have since cost taxpayers almost $150 billion.
Why current mortgage rates wouldn't last under a new system
Clearly, this system needs reform. Assuming the government will no longer take on the ultimate risk of underwriting mortgages, that risk will pass back to private mortgage and mortgage finance companies. These companies most likely pass this risk on to customers in the form of a risk premium.
Current mortgage rates are at an even 5 percent. Though this is up from last year's all-time lows, it is still well below the forty-year norm for mortgage rates. A risk premium would force mortgage rates higher.
The "when" and "how" of reforming the mortgage system remain up in the air, but some type of reform seems inevitable--and so do higher mortgage rates.
