President Obama Comes Out for Subsidizing Mortgage Backed Securities

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Tuesday, 06 August 2013 04:51

President Obama is going to announce a plan whose main goal appears to be subsidizing mortgage backed securities. Unfortunately the readers of the Washington Post article on the piece probably would not realize this fact.

The article simply repeats the Obama administration's assertion that government backing is needed for 30-year mortgages to exist, which it asserted are the backbone of home ownership.

"Traveling to Phoenix on Tuesday, Obama is planning to call for a new system, built in part on government backing, that will enable wide access to 30-year mortgages, which are a rarity in other countries. That will require, officials said, some form of government guarantee that means lenders will be reimbursed by taxpayers in the event of a housing catastrophe like the one that occurred several years ago."

In fact, government backing is not necessary for 30-year mortgages, as is shown by the existence of the 30-year jumbo mortgages which are too large to be eligible for government guarantees. The interest rate on these mortgages is typically 0.25-0.50 percentage points higher than the interest rate on conforming loans that can be purchased by Fannie Mae and Freddie Mac.

So the story here is not really about the existence of 30-year mortgages, but rather the price. The program being pushed by President Obama effectively subsidizes mortgage interest rates by subsidizing mortgage backed securities. If the goal to make homeownership more affordable for moderate income people, this is an extremely inefficient way of doing so.

Under the Obama administration's proposal the vast majority of the subsidy would go to higher income homeowners since there will be a bigger subsidy for people who take out bigger mortgages. It is also not clear that a 30-year mortgage is always the best financing instrument.

Alan Greenspan famously noted that many homeowners lose money by taking a 30-year mortgage when a shorter-term mortgage would often involve lower fees. (Unfortunately he did this at a time when the housing bubble was taking off and homeowners were increasingly diving into adjustment rate mortgages, often with teaser rates.) This is especially likely to be the case for lower income homebuyers who move more frequently. In such cases, the government will be costing homeowners money by encouraging them to take out a 30-year mortgage.

It would have been appropriate to include the views of an expert who could have made these points to readers.