Economists Look Beyond Housing Crisis to Propose Long-Term Reform

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BY CHAD REESE – As the U.S. housing market struggles to right itself, many Americans may be hoping the worst is over.


While real estate prices continue to fall in parts of the country, increases in the sales of existing homes have many breathing a sigh of relief.

Even if stability returns in the short term, however, many are claiming that the government-sponsored enterprises (GSEs) that dominate the U.S. mortgage market need serious reform to avoid a repeat of the housing market crash.

Former Senior Economist at Freddie Mac and current Mercatus Scholar Arnold Kling is one policy expert who has recently unveiled what he sees as vital to long-term reform.

“The key to successful reform in housing finance is clarifying the public policy objectives,” said Kling. “Vague and contradictory objectives played a large role in the catastrophe that befell Freddie Mac and Fannie Mae.”

Kling’s concerns highlight a belief shared by other economists who worry that large, government-protected mortgage giants can lead to confusing or inconsistent policy objectives as a small group of centralized GSEs attempt to tackle a diverse and complicated set of issues.

Lawrence J. White, professor of economics at New York University’s Stern School of Business, has also expressed concern that GSEs are the wrong tool for the job that lawmakers want them to do.

“We shouldn’t try to use the financial system to address social externalities, low-income housing goals, or maintenance of residential property housing values,” White said. “A wholly private mortgage financing (except for FHA and Ginnie Mae, to help low- and moderate-income first-time home buyers) is both desirable and feasible.”

Others have focused their suggestions for GSE reform on the costs involved in such programs. Dwight Jaffee, professor of banking, finance, and real estate at UC Berkeley, argues that GSEs create costs to taxpayers that far exceed expected benefits.

“The U.S. foreclosure rate at the end of 2009 was 4.58 percent for all mortgages and 3.31 percent for prime mortgages, and that’s not to mention 15.58 percent for subprime loans,” said Jaffee. “In contrast, Spain and the U.K. are two of the most distressed countries in the Eurpoean Union, but their foreclosure rates are 0.24 percent and 0.19 percent respectively.”

Jaffee’s concerns are particularly timely since Fannie Mae and Freddie Mac may end up costing taxpayers as much as $400 billion as Congress struggles to save the two mortgage giants while debating ways to balance the federal budget.

Even worse, Peter Wallison, co-director of the American Enterprise Institute’s program on financial policy studies, believes that the benefits of the GSE structure may have already been realized, which, if that $400 billion figure turns out to be accurate, means that money will be more or less dead weight added to an already soaring national debt.

There is some room for optimism, however. Each of these economists, along with Anthony Sanders, professor of finance in the school of management at George Mason University, and Michael Lea, director of the Corky McMillin Center for Real Estate at San Diego University, have together created “Five Proposals for a New Housing Finance System in the United States” in conjunction with the Mercatus Center at George Mason University.

While the five proposals vary from one another, they each look beyond the crisis to present unique proposals for the long-term reform of the U.S. mortgage market. These proposals, along with a chart summarizing the main concerns, suggestions for reform, and possible outcomes from each plan, are available at

Chad Reese is a communications associate at the Mercatus Center at George Mason University.





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