Academic journal article Federal Reserve Bank of St. Louis Review

The New Structure of the Housing Finance System

Academic journal article Federal Reserve Bank of St. Louis Review

The New Structure of the Housing Finance System

Article excerpt

14 The Eleventh District Cost of Funds rose from 9 basis points below the three-month Treasury rate in 1972 to 61 basis points above it in 1987. (The Eleventh District Federal Home Loan Bank is located in San Francisco and the district includes the states of Arizona, California and Nevada. Its Cost of Funds, measuring the interest rate on deposits paid by S&Ls in the district, is one of the common indices for ARMs.)

15 See, for example, Brewer (1989), Brumbaugh (1988) and Kane (1985). Brewer's estimate is the lowest, Kane's the highest. Brumbaugh's is -12.5 percent.

16 Under the 1967 federal budget reform, purchases of subsidized mortgages AFTER 25 YEARS OF ECONOMIC evolution and 15 years of political turmoil, the U.S. housing finance system has changed in fundamental ways, and the structure of the new system is becoming apparent. The system is still intended to allocate credit to housing and hold mortgage rates below their free-market level, but this subsidy is provided through different institutional arrangements. The dominant institutions are now extremely large government-sponsored enterprises (GSEs) which operate in the secondary mortgage market, issuing securities that are backed by mortgages and buying mortgages originated by other institutions. They have taken the place of small local savings and loan associations which make loans directly to homebuyers and hold the mortgages in their own portfolios. The cost of the subsidy falls on taxpayers who bear the risk of failure by the GSEs.

The public purpose of government intervention in the housing finance system has always been to promote homeownership, giving force to a social preference that derives from a widely held but rarely analyzed belief that homeowners are better citizens, because they "have a stake in society." Subsidies are appropriate because families will not take this social benefit into account in deciding whether to buy a home. The system also has two subsidiary goals: (1) countercyclical support for housing production; and (2) geographic equity (as defined by public policy) in the mortgage market. The latter is more directly related to the purpose of promoting homeownership.

Achieving these purposes is the responsibility mainly of privately owned institutions which are supposed to meet them while maximizing profit and avoiding direct cost to taxpayers. This is also true of the major housing finance agencies within the federal government; they do not normally receive funds from the U.S. Treasury. The private as well as public institutions operate under statutes which define their powers, limitations and privileges, and delineate what they can hold as assets and liabilities. To some extent, they compete against each other.

The home mortgage market consists of some $3 trillion of household debt, nearly all of it held by private institutions, of which more than $1 trillion is explicitly or implicitly guaranteed by the federal government (not counting deposit insurance). There is continuing tension between the public purposes of the system and the safety and soundness--and profits--of the privately owned institutions that predominate in it.

This paper first describes the present structure of the housing finance system, contrasting it with the traditional system and explaining why the system has changed. It concludes with a discussion of the major issues that will face public policy over the next few years.


Mortgage and Housing Markets

The mortgage market has traditionally been separate from other capital markets, because mortgages differ in key respects from other debt instruments. A home mortgage is a loan to an individual or couple for the purpose of buying a particular house. The amount the lender is willing to loan depends on the value of the property. The mortgagor promises to repay the loan over time. If he or she fails to do so, thus defaulting on the mortgage, the lender can foreclose, take title to the property, and sell it to someone else. …

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