A Privatized U.S. Mortgage Market
Dwight Jaffee
Haas School of Business
University of California, Berkeley
Presented to Conference on
The GSEs, Housing, and The Economy
Reagan Center, Washington DC, January 24, 2011
 Dwight Jaffee, 2011 Page 1
Agenda

I briefly comment on the cost/benefit of reestablishing
the GSEs, and conclude they should/will be abolished.

The issue is then to recreate the U.S. mortgage market.

My proposal is to establish a primarily private market
for U.S. mortgage originations and investments. This
includes transition steps to get from here to there.

I will also comment on the primary alternative, namely
to have the U.S. government guarantee all conforming
mortgages, including hybrid variations on this proposal.
 Dwight Jaffee, 2011 Page 2
Abolishing the Housing GSEs


It is clear that the GSE private/public hybrid has
created immense losses for U.S. taxpayers.
But were there benefits? Looking at 3 main mission
goals, my conclusion is that GSE benefits are small.



“mortgages for low- and moderate-income
families (and) central cities, rural areas, …”
“stability in secondary market for residential
mortgages” (i.e. on-balance-sheet portfolios)
“promote access to mortgage credit throughout
Nation” (i.e. mortgage-backed-securitization).
 Dwight Jaffee, 2011 Page 3
A Private Mortgage Market Proposal
 Basic
principle: In absence of a market failure,
private markets generally dominate government.
 FHA/HUD
programs should continue to support lowincome, first-time, homebuyers and multifamily.
 Transition
plan: Reduce conforming loan limit by
$100,000 annually until it reaches zero. Allow
retained balance sheet portfolios to run off.
 Safety
net: FHA and GNMA could be rapidly
expanded for conforming mortgages if needed.
 Dwight Jaffee, 2011 Page 4
Privatized Mortgage Market: Q&A
Q: The GSEs and FHA now run 95% of the US
mortgage market. How can we run the market
without substantial government support?
A: This is crowding out 101. Subsidized government
credit programs always crowd out private activity.
European evidence is that private mortgage markets
outperform government dominated markets.
Q: Who will fund all the mortgages if it is not GSEs?
A: The same investors who purchase GSE debt/MBS
will hold high quality private mortgage securities.
 Dwight Jaffee, 2011 Page 5
Share of Total Home Mortgages
Outstanding, by Holder
Depository Institutions
Fannie Mae and Freddie Mac
Market Investors
80%
70%
60%
50%
40%
30%
20%
10%
0%
1950
 Dwight Jaffee, 2011 Page 6
1960
1970
1980
1990
2000
2009
Privatized Mortgage Market:
More Q&A
Q: Will mortgage rates rise? House prices fall?
A: Mortgage rates may temporarily rise and house
prices may face some temporary downward pressure.
Ultimately, safer mortgages will lead to lower rates.
Q: What about “American Dream” of homeownership?
A: We produced 12 million single-family homes during
2000s. The problem is to make these affordable.
Western European countries have achieved comparable
homeownership rates with virtually no government role.
 Dwight Jaffee, 2011 Page 7
Private Mortgage Market Performance:
Evidence from Western Europe
 Very
limited government support or intervention of
any form (except for programs comparable to FHA).
 Borrowers,
lenders, government are unified to create
very safe mortgage loans so default is a rare event.
 Europe
shows major diversity in contract features
(FRMs, ARMs, prepayment, recourse, maturity, etc.)
 There
is no evidence of low homeownership rates.
 Mortgage
 Dwight Jaffee, 2011 Page 8
rates are lower, markets are more stable.
Comparative Performance of U.S. and
15 Western European Countries
 Home
ownership rates: U.S. is 8th of 16.
 Housing
 House
Start Volatility: U.S. is 5th of 16.
Price Volatility: U.S. is 4th of 16.
 Mortgage
rate spread: U.S. is 1st of 16.
 Mortgages
 Dwight Jaffee, 2011 Page 9
outstanding/GDP: U.S. is 5th of 16.
European Mortgage Troubles
Table 4: Troubled Mortgages, Western Europe and the United States
Belgium
Denmark
France
Ireland
Italy
Portugal
Spain
Sweden
UK
U.S. All Loans
U.S. Prime
U.S. Subprime
 3 Month
Arrears %
0.46%
0.53%
Impaired or
Doubtful %
Foreclosures
Year
2.44%
0.19%
2009
2009
2008
2009
2008
2009
2009
2009
2009
9.47%
6.73%
25.26%
4.58%
3.31%
15.58%
2009
2009
2009
0.93%
3.32%
3.00%
1.17%
3.04%
1.00%
0.24%
Source: European Mortgage Federation (2010) and Mortgage Bankers
Association for U.S. Data.
 Dwight Jaffee, 2011 Page 10
A Private Market will Provide
Expanded Mortgage Choice
 Adjustable
or fixed rate mortgages
 Prepayment penalties or not; Recourse or not;
 Alternative amortization patterns, maturity.
 30-year fixed rate mortgages will be more available:
– GSE MBS force all interest rate risk on investors;
– GSEs standardized no prepayment penalties;
– Long-term mortgages promoted through covered
bonds; Denmark among other examples.
– Private markets dominate TBA forward markets
 Dwight Jaffee, 2011 Page 11
A Private Market
will Create Safer Mortgages
 Private
market will contain 3 mortgage investors:
– Private label MBS investors;
– Covered bonds (bank securitization) investors;
– Bank portfolio investors.
 In
the absence of government interventions, these
investors must face the default risk directly:
– European markets show that, without government
backstops, investors opt for safe mortgages.
– Key will be lower LTV ratios and recourse.
– Bank regulators must enforce the high standards.
 Dwight Jaffee, 2011 Page 12
Alternative Proposal to Replace the GSEs
A
key alternative proposal is to create government
guarantees for all conforming-size mortgages.
– I grant this is better than insuring the GSEs;
– But European data indicate no market failure.
 Inevitably,
the government will subsidize risky loans.
Uniform result of government insurance programs:
– Unable to deny program access to high-risks;
– Failure to impose risk-based pricing;
 Government endorses risk-taking, then must bail out.
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