AEI - How Government Policies Brought Down The Housing Market

Editors Note: This article is derived from detailed report written by Edward J. Pinto, and Peter J. Wallison, of the American Enterprise Institute. It is used with their permission. 

The US housing market is in serious trouble, far worse than in almost any other developed country.

Since 2006, housing prices have fallen 30 to 40 percent in most areas; millions now owe more on their mortgages than their houses are worth, and millions more have only slivers of equity. The average homeowner today has 7 percent equity in his or her home, versus 45 percent as recently as 1990.

The private housing finance system has virtually disappeared, and the government system that remains is pursuing the same policies that produced the current problems. The affordable housing goals imposed on Fannie Mae and Freddie Mac in 1992 were the major contributors to both the deterioration in underwriting standards between 1992 and 2008 and the growth of an unprecedented ten-year housing bubble that suppressed delinquencies and stimulated the growth of a private securitization market for subprime loans.

But other government policies are also to blame for the deterioration in the US housing market, including the thirty-year fixed-rate mortgage, the mortgage interest tax deduction, the right to refinance without penalty, and the Community Reinvestment Act. Until Fannie and Freddie’s market dominance and the government’s role in the housing finance system are substantially reduced or eliminated, the United States will continue to have an inferior and unstable housing market.
Click the link below to view a slide show detailing how government policies led to the housing bust.

Most of the discussion about the role of government housing policies in the mortgage meltdown and the subsequent financial crisis has focused on the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac and the effect of the affordable housing (AH) goals in creating demand for subprime and other risky loans.

By 2008, before the US financial crisis began in earnest, 28 million such loans were outstanding in the United States—half of all US mortgages—and 74 percent of them were on the books of government agencies or government-backed or regulated entities. Fannie and Freddie were by far the largest source of demand for these loans, but the AH goals were only one element in a series of government housing policies that were key factors in the financial crisis and the subsequent depression in the housing market. Cumulatively, these policies have had a devastating effect on the overall health of the US housing system.

The United States is the only developed country with a significant government role in housing policy. Most other countries leave housing finance largely to the private sector, have less volatility in housing starts and house prices, and do not suffer the recurring crises characteristic of the US market.

Nor does the United States, for all the funds it has lavished on housing, have a particularly high homeownership rate, although US housing policies have for many generations focused on increasing homeownership.

In a recent presentation that compared US government housing policies with those of fifteen developed European Union countries, Dwight Jaffee found that the United States ranked eighth in homeownership and had the third-highest mortgage rate in relation to the applicable risk-free rate. These housing markets were also more stable than the US market and had lower mortgage default rates.[1]

Without government interference, a private US market would offer homeowners interest rate reductions for substantial down payments, limits on refinancing, and more rapid amortization—features that borrowers would find desirable. The results would be more home equity, lower leverage, lower interest rates, and greater stability in downturns. These features of private markets account for the healthier and more stable housing markets in Europe.

Instead, the US housing market today exhibits a large number of unhealthy conditions, almost all a direct result of government housing policies. These include disastrously low levels of home equity, government policies that continue to promote low-quality loans, mortgage-backed securities that are unattractive to long-term investors, a dysfunctional appraisal system, procyclical bank capital regulation that subsidizes excessive mortgage investment, millions of defaulted but unforeclosed mortgages, a new and overly complex regulatory structure in the Dodd-Frank Act for residential mortgage lending, and a series of advantages for a continued government role in the housing market that will make reviving a private mortgage financing market highly improbable.

You may read the entire report here.