The GOP Mortgage Plan: Con and Pro
Is there an economic case in favor? A couple weeks ago, University of Chicago economist John Cochrane wrote a critique of the current fiscal stimulus plans and concluded with the following recommendation:
Against modest benefits, the proposed subsidy carries enormous costs. Allowing any credit-worthy borrower to gain access to wildly subsidized lending would lead to a flood of refinancing. Today, Americans owe $10 trillion worth of housing debt and own $19 trillion worth of housing wealth. Logic suggests that a 1.35% interest-rate subsidy on $10 trillion of debt could cost taxpayers upwards of $135 billion.
Subsidizing mortgages is an idea from the New Deal, not the Republican playbook. Fannie Mae and the Federal Housing Administration were set up by liberal Democrats to encourage borrowing. Subsidizing interest rates appealed to big-government interventionists because the expense is kept off federal balance sheets, at least for a while. The true costs of Fannie and Freddie were long shrouded, despite the efforts of some Republican senators. Likewise, the full costs of subsidizing 4% mortgages will appear only over time, as the government is put on the hook for default after default.
there is a plausible diagnosis and a logically consistent argument under which fiscal stimulus could help: We are experiencing a strong portfolio and precautionary demand for government debt, along with a credit crunch. People want to hold less private debt and they want to save, and they want to hold Treasuries, money, or government-guaranteed debt. However, this demand can be satisfied in far greater quantity, much more quickly, much more reversibly, and without the danger of a fiscal collapse and inflation down the road, if the Fed and Treasury were simply to expand their operations of issuing treasury debt and money in exchange for high-quality private debt and especially new securitized debt.John was not speaking about the Republican mortgage plan (it had not been proposed yet), so I am not exactly sure of his view of it, but his prescription above sounds a lot like the plan, as long as the government makes sure the mortgages are of high quality. Ed might respond to John that if the private debt were high quality, it would not command much of a premium over government bond rates, so the Republican policy would be unnecessary. John might respond to Ed that this would be true in normal times, but credit markets are not functioning as they do in normal times. And the debate goes on....
How might the feds ensure repayment of these mortgages? One possibility is to make them recourse mortgages (that is, the lender would have recourse to the borrower's other assets, if the borrower defaults and the house value falls below the mortgage principal). It could also use the long-arm of the IRS as the collection agency. This latter provision is one advantage the federal government has over private lenders.
Update: I was wrong guessing the implications of John Cochrane's recommendation. He writes me:
I'm with Ed on this one. A vast program to subsidize mortgages is a terrible idea. I don't mind terribly if the Fed buys mortgage backed securities issued at market rates, with a steely eye on not overpaying and buying junk, and so that those securities can be quickly resold when the flight to quality passes. (This is sort of a real-bills doctrine approach.) Even here, though, there are better uses for the Fed's attentions. The conforming (government guaranteed) mortgage market is the one thing that's working reasonably well. That's not an argument for a massive subsidy program on the rates, and especially not direct lending to households. I think the government is way too deep in the mortgage market already.Thanks, John. Sorry for having put words in your mouth, incorrectly.
As for me, I don't see as large a distinction in principle between John's willingness to buy high-quality mortgage-backed securities and the Congressional proposal of making direct mortgages at rates that exceed the government's cost of capital, as long as the Treasury has mechanisms in place to ensure collection.