The U.S. mortgage market is undergoing major changes. The federal government will take a smaller role on the supply side, and perhaps even the demand side.
Government intervention on the supply side of the mortgage market began with the establishment of Fannie Mae and Freddie Mac. Fannie Mae is the short name for the Federal National Mortgage Association started in 1938 as part of the New Deal legislation. The agency became a public corporation in 1968, but retained an implied government backing.
Freddie Mac is the Federal Home Loan Mortgage Corporation created with government support in 1970. Both Fannie and Freddie have long bought mortgages from banks, thereby providing more liquidity in the mortgage market.
With these loan buyers standing ready, banks willing increased the supply of mortgage loans. The system had its intended effect of increasing available loans for home ownership.
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From 1970 through 2010, mortgage debt outstanding grew an average of 9 percent per year. Despite this rapid rise in available credit the U.S. home ownership rate is only about 5 percent higher than in the 1960s. Even after the financial crisis, Fannie and Freddie make the market. These and other federal agencies account for 90 percent of all new mortgage loans. This could all soon change.
The U.S. Treasury Department announced that the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, will begin winding down their role in the mortgage market. Fees charged for guaranteeing mortgages that banks sell to investors will rise, banks will have to hold more capital to get the guarantee, and a higher down-payment will be required from the borrower.
These changes will decrease the supply of mortgage loans. And a proposal to lower the U.S. federal budget deficit may decrease demand.
The White House Deficit Commission, of which Idaho's Sen. Mike Crapo was a member, called for a limit on the tax deduction for mortgage interest. Even if adopted for only higher income households the lower overall demand will reduce the quantity of mortgage loans.
Crapo disagrees with this proposal and wants to keep the mortgage interest deduction. Additionally, he says "modifying or eliminating the mortgage interest deduction is not necessary in order to bring our budget into balance."
While this is true, the interest deduction is a subsidy, increasing demand in the housing market above what it would be without government intervention. Higher homeownership has long been the policy goal of both this tax incentive and the excess mortgage loan supply provided by Fannie and Freddie.
However, there is little evidence that homeownership contributes to economic growth, and may in fact increase volatility. Countries with higher homeownership rates, like Italy and Spain, face mounting economic problems while low ownership rate countries, like Germany and Switzerland, were hit less hard and are growing strong.
The American dream of homeownership may not do us all that much good, but the policy is likely to stay with us even as we say goodbye to Fannie and Freddie.
Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. His column, published weekly at IdahoStatesman.com, appears every other week in the Business Insider.