The Middle Class Still Needs Mortgage Help

Douglas J. Elliott
Douglas J. Elliott Former Brookings Expert, Partner - Oliver Wyman

March 9, 2011

The federal government will not, and should not, stop providing all support for mortgages. However, there is a growing consensus, backed by the Obama administration, that the aid must be more targeted, less expensive and transparent.

Politicians loved the way that government-sponsored enterprises like Fannie Mae and Freddie Mac seemed to provide wide and deep support to middle-class voters, and others, at no apparent budget cost. That was a fool’s game, unfortunately. Subsidies cost money, either up front or eventually, and we’re paying those costs big time now.

We need to aim mortgage aid at the less well-off citizens who can afford to make mortgage payments, but need some help with their first home purchase or perhaps even to trade up. (The administration is right that we should also help some people to rent, when they need help with shelter and do not have the stable income levels to support the risk of a mortgage.)

The well-off do not need our help with housing, yet they already receive massive tax subsidies in aggregate, much larger than the annualized cost of our rescues of Fannie and Freddie. This is because the mortgage interest deduction is gives a much larger tax break to those at higher income levels with bigger houses.

There is a legitimate question as to how well the private sector can provide the full level of mortgages needed after so many decades in which Fannie and Freddie warped the housing finance system. Luckily, we can find out by creating an intelligent transition plan. We could phase out those companies by gradually raising the guarantee fees they charge, to price them out of the market, or by lowering the maximum size of mortgage they cover, or both. We would then see if the private markets could fill the void, as they should be able to do. If not, we can rethink at that point before serious harm is done.

We will need new regulation to replace the de facto regulation imposed on the markets by Fannie and Freddie through loan underwriting guidelines and to correct any other issues with consumer protection. The regulations should aim at ensuring transparency for borrowers and financial markets, protect the safe operation of the financial institutions, and encourage standardization where it is appropriate.